The Financial System Inquiry has explicitly rejected leading bankers' claims that Australian bank capital requirements are out of line with international standards.The interim report of the Inquiry, released on Tuesday, contains a detailed critique of the banks' case for an easing of capital requirements. It generally approves of the current prudential system and is looking at options which could further toughen regulations - including UK-style ring-fencing of retail banking operations.Inquiry chair David Murray had earlier suggested that regulators - particularly APRA - might be applying the Basel rules too aggressively. But the report argues in detail that this view is wrong."In fact, banks' actual capital ratios do not appear excessively high, including when compared to countries at a similar level of financial development," the interim report says on page 3-36. "Australia's prudential framework does not seem to require excessive capital levels ... In addition, a growing body of work suggests that the social costs to higher bank equity funding are smaller than is often presumed."Given Murray's own background as a former CBA CEO, the report's findings may well be fatal to this long-standing bank complaint.In another disputed area, the impact of housing lending, the report goes further than regulators such as the Reserve Bank have done. It argues that housing has become "a significant source of systemic risk" as banks have increased their exposure to mortgages.The report also emphasises a need to fight public perceptions that banks will be bailed out during a crisis. It fears the assistance to financial institutions during the global financial crisis created perceptions that institutions "are too-big-to-fail and therefore receive an implicit government guarantee".The panel says the government can take several steps to make failures less likely, as well as "steps to make it more likely or more credible to achieve orderly failure without Government support."It approves of the aim of orderly resolution of bank failures - that is, regulator intervention to help keep critical services and payments going while a bank is reorganised or its assets sold off.And it points to the importance of finding "credible ways to impose losses on creditors" when banks fail, so that crises can be resolved with "minimal use of taxpayer funds". But it also notes the "complexities" involve in making a credible promise to impose losses on creditors.It suggests regulators can do more to prepare for an event that would require them to use their resolution powers. The panel asks for views on four possible changes:- Giving regulators more ability to impose losses on the creditors of a failed institution.- Strengthening regulators' resolution powers.- Higher capital requirements for so-called D-SIBs - essentially, the Big Four banks.- Ring-fencing bank activities such as retail banking, requiring them to be partially separated from the rest of the institution.The panel says ring-fencing would be the "most burdensome" option, imposing restructuring costs, reducing the benefits of diversification for banks, and could create barriers to foreign banks expanding here and Australian banks expanding overseas.But the interim report does note that because Australia's banks