By Patrick Rucker

WASHINGTON (Reuters) - Regulators may hurt the economy and push borrowers toward non-bank lenders if they set too-high capital standards for Wall Street, Neel Kashkari, president of the Federal Reserve Bank of Minneapolis, said on Monday.

The U.S. banking system needs deep reform to prevent a repeat of the 2008 financial crisis and Wall Street firms should hold more capital to brace against economic shocks, said Kashkari, who was a Treasury Department official under the George W. Bush administration.

But regulators must be mindful that forcing banks to hold capital means those institutions may have less money to lend, Kashkari told the Peterson Institute for International Economics.

"More capital has downsides that need further exploration," he said in a speech. "In particular, higher capital could raise the cost of lending and potentially reduce economic activity."

Kashkari was addressing a symposium for preventing Too Big to Fail - shorthand for a government rescue of Wall Street.

Banks hold cash, government bonds and other easy-to-sell assets to brace themselves against a crisis and Kashkari said controlling those capital levels is one of the simplest ways to strengthen banks.

Still, he warned that demanding too much from conventional banks could give non-banks an edge.

"Increased capital standards for large banks have the potential to push risk to non-banks, such as hedge funds and insurance companies."

Consumer protections can stiffen into red tape if regulators are not careful, Kashkari said, pointing to a personal experience trying to get a home loan.

The former Goldman Sachs executive offered his checking account details, rental history and other documents before his longtime bank would clear him for a mortgage.

"I just personally felt it," Kashkari told reporters after Monday's speech. "It was an extraordinarily painful process."

Some creditworthy borrowers might turn away from banks if they face unreasonably stringent terms and paperwork, he said.

Still, Kashkari said he would continue to advocate his preferred method for bolstering banks: increase capital.

"If we're not going to act now, we're never going to act," he said.

(Reporting By Patrick Rucker; Editing by Andrea Ricci and Meredith Mazzilli)