The head of the Federal Reserve and a key U.S. lawmaker on Thursday backed away from a controversial provision of the Obama administration's financial regulation reform plan, saying new oversight by the Fed on systemic risk should be shared with other regulators.

Fed Chairman Ben Bernanke told a congressional panel that a new council of financial regulators, not just the Fed, should monitor big-picture risks threatening the financial system.

There were some, myself included, who earlier this year thought that the Federal Reserve would have a larger role in this. Now it looks like it will be part of a conciliar structure, said House of Representatives Financial Services Committee Chairman Barney Frank at a hearing with Bernanke.

The comments from Frank and the Fed chairman come amid growing skepticism in Congress about an administration proposal to give the Fed the lead role in policing the economy for systemic risk, albeit in coordination with an inter-agency council.

The Fed is well suited to supervise major financial institutions whose failure could hurt the economy, Bernanke told Frank's committee.

He also said all systemically important financial firms should answer to a consolidated regulator, whether or not the firms own banks.

But an inter-agency council should be used to monitor the very broadest sorts of risk, he said, placing new emphasis on an idea embraced by increasingly vocal critics of the Fed.

While the administration has backed the idea of creating an inter-agency council to work with the Fed, it has been firm on its determination to place the most power in the Fed.

FED FAILURES CITED

Some of the Fed's critics point to the failure of the Fed, along with other regulators, to spot the threat to the financial system posed by overexposure of banks and other firms to the housing market which eventually helped cause the credit crisis and push the world into a recession.

World Bank President Robert Zoellick on Monday sounded a cautionary note about granting greater regulatory power to the Fed, saying there had been lapses by central banks in monitoring risks in the run-up to the crisis.

Bernanke said it was a good idea for one single regulator to be responsible for supervising individual firms.

However, the broader task of monitoring and addressing systemic risks that might arise from the interaction of different types of financial institutions and markets -- both regulated and unregulated -- may exceed the capacity of any individual supervisor, he said.

Instead, we should seek to marshal the collective expertise and information of all financial supervisors to identify and respond to developments that threaten the stability of the system as a whole.

The comments appeared to represent a change of tone by Bernanke. He told a congressional committee on July 24 that taking on formal responsibility for supervising the broad health of the financial system would be a natural outgrowth of the central bank's existing duties.

SHIFT NOT SURPRISING

A shift in emphasis by the Fed chairman would not be surprising, said Joe Engelhard, policy analyst at investment research firm Capital Alpha Partners in Washington.

There's been a lot of negative reaction, particularly by Republicans, on the House side. In the Senate, (banking committee) Chairman Christopher Dodd hasn't been too supportive either of the administration's proposal, Engelhard said.

Frank has been trying to find a new formulation that would give the council more power, but preserve a central Fed role.

It would be smart for the chairman of the Federal Reserve to take that approach, as well, Engelhard said.

A key to the final outcome of the debate will be if the Fed gets clear power to intervene when systemic risk is detected.

Frank still wants the Fed to have all the authority it needs to address a future AIG or a future Lehman Brothers ... They're perfectly willing to beef up the oversight council because at the end of the day, as long as the Fed's got the authority, it can do what it has to do, he said.

On another front, Bernanke said in his comments prepared for delivery on Thursday that a new special resolution authority should be created to allow the government to wind down a failing systemically important financial institution.

(Writing by Kevin Drawbaugh and William Schomberg; Editing by Andrea Ricci)

Ben Bernanke