WASHINGTON (Reuters) - U.S. regulators are expected to significantly reduce the extra capital banks must hold under a proposed rule that has drawn aggressive pushback from Wall Street, said eight industry executives in regular contact with the agencies and regulatory officials.

Bank regulators led by the Federal Reserve in July unveiled the "Basel III" proposal to overhaul how banks with more than $100 billion in assets calculate the cash they must set aside to absorb potential losses.

The agencies said it would increase aggregate capital by around 16% for the roughly three dozen affected lenders. That figure is expected to fall sharply as regulators embark on a sweeping rewrite of the draft, the people said.

The regulatory discussions are in their early stages and no decisions have been made, the people said. The agencies have said they are analyzing hundreds of public comments and data from banks on the impact of the proposal.

The biggest capital savings will come from changes to how banks will have to calculate potential losses from operational risks, which is the costliest plank of the proposal, three people said. In that section, banks had been pushing regulators to reduce the risk weights for fee income associated with lending services, such as investment banking.

Officials are also expected to scrap or reduce higher risk weights on mortgages to low-income borrowers and on renewable energy tax credits, the people said.

Fed Vice Chair for Supervision Michael Barr has begun rewriting the proposal, working with Fed Chair Jerome Powell, three people said. Powell, who is testifying on Wednesday before Congress, is seeking "significant" changes, said one government official.

The official and other sources declined to be identified discussing private regulatory issues. The Fed declined to comment.

While Barr has said he would consider adjustments, including to the mortgage weights and operational risk calculations, the extent of the expected capital reduction and other details of the agency discussions are being reported here for the first time.

They show Wall Street is making headway in an extraordinary effort to kill the proposal, which has stirred up criticism from lawmakers including some prominent Democrats. Banks have mounted advertising and grassroots campaigns, lobbied Congress, and have signaled they may sue. They have also urged regulators to scrap the draft and re-propose it.

"I don't recall anything being quite this intense at least say, in the last 25 years," said Camden Fine, former head of the Independent Community Bankers of America who had led successful campaigns to carve small banks out of post-crisis rules.

Officials have not decided whether to re-propose the rule, three said, which would delay its completion and potentially push it into a new presidential administration.

Barr has said the rules will bolster the banking system against unforeseen shocks which were underscored by last year's bank failures. He has also pointed out that lenders' claims following the 2007-09 global financial crisis that higher capital rules would hurt the economy did not come true.

Spokespeople for the Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of the Currency, which jointly drafted the rule, declined to comment.

"The opposition to the Basel III Endgame proposal is coming from every sector of our economy," said Kevin Fromer, CEO of the Financial Services Forum, which represents global banks.

"We would hope the agencies are hearing these concerns and are working to find a way forward that will support our economy."

DISSENT

The Basel proposal implements international capital standards agreed by the Basel Committee on Banking Supervision following the global financial crisis. Banks say the draft goes further than the Basel accord and overstates their risks.

The Bank Policy Institute, a bank group, has hired top attorney and former Labor Secretary Eugene Scalia to build a potential lawsuit, one of the people said. The intensity of the opposition caught officials by surprise, two other sources said.

Regulators are also grappling with rare dissent among the Fed's board. Governors Michelle Bowman and Christopher Waller voted against the proposal, saying it would hurt borrowers. Vice Chair Philip Jefferson and even Powell also voiced skepticism.

Such dissent can also be "extremely valuable" when litigating by showing the court that even the experts are divided on the subject, Scalia said at an October event.

Powell told reporters in November that the Fed would reach a final rule with broad support on the U.S. central bank board.

Bankers say Fed officials, including Powell, are listening. Since September, Fed staff, Powell, Barr, Bowman and Jefferson combined held at least 50 meetings or calls with hundreds of industry executives about Basel, Fed logs show.

Powell discussed Basel with the CEOs of Goldman Sachs ( GS ) and Barclays, the logs show. The Fed chair also met or spoke with other top bankers in recent months, including the CEOs of JPMorgan ( JPM ) and Bank of America ( BAC ), according to his calendars which do not say what was discussed. The banks declined or did not respond to requests for comment.

Another challenge for Fed officials will be reaching an agreement with the FDIC, which is chaired by Wall Street critic Martin Gruenberg.

Early Basel drafts were weaker, said two people. Another person briefed by regulators said that one of those drafts, from early 2023, envisaged a single-digit capital increase. But some officials, particularly at the FDIC, pushed for bigger capital hikes, especially after Silicon Valley Bank collapsed, all three said.

Some officials hope to complete the rule by this summer, but that timeline could prove to be too ambitious, one regulatory official said.

Gruenberg did not respond to requests for comment.