The U.S. House Financial Services Committee voted on Wednesday to approve a proposal that would empower government regulators to break up large financial firms that threaten economic stability.

The measure, offered by Democratic Representative Paul Kanjorski, was added as an amendment to a broader bill that was expected to face a committee vote later, possibly on Friday. Full House action was unlikely until next month.

The government last year stepped in with massive bail outs of firms such as American International Group Inc and Citigroup Inc , fearful the collapse of a large firm could bring down the entire financial system.

Kanjorski, the chairman of the House capital markets subcommittee, proposed assigning the power to preemptively break up financial firms to a Financial Services Oversight Council, subject to review in some cases.

With a focus on the 50 largest U.S. financial firms, Kanjorski's amendment would require the council to evaluate several factors in determining whether to take action against a firm, including size, exposure, leverage and relationships.

The council could order firms to be put under tougher oversight, to halt or change their activities, to limit mergers and acquisitions, and in extreme cases, to break up.

Mandated divestitures of more than $10 billion would require the Treasury secretary's approval, while those above $100 billion would require the approval of the president.

The amendment would cover insurance companies, banks, hedge funds, whoever may be in an exposed area of causing systemic risk, Kanjorski said at a committee working session.

Firms could appeal council actions under the amendment, which the committee passed with 38-29 vote, largely on party lines.

The committee's broader bill had already proposed new powers for regulators to police, take over, restructure and shut down firms that pose a systemic risk.

The bill, as amended, comes amid a broad push by the Obama administration and Democrats to tighten bank and capital market rules in response to last year's financial crisis.

A bill introduced last week by banking committee Chairman Christopher Dodd, a Democrat, also called for establishing a council of financial regulators that could require companies that threaten the economy to divest holdings.

LOBBYISTS PUSHING BACK

In both the House and the Senate, financial lobbyists will continue to try to water down this new and intrusive federal regulatory power, said Joseph Engelhard, policy analyst at investment firm Capital Alpha Partners.

If a new break-up power does survive the legislative process, Engelhard said, it is unlikely a council of numerous financial regulators would be able to agree on such a radical step as breaking up a large bank, except in the most unusual circumstances, and that the Treasury Secretary ... would have the ability to veto any imprudent use of such power.

Kanjorski added he will coordinate with European Union officials on the issue because they share similar concerns.

EU regulators are set to turn the spotlight on 28 European banks bailed out by governments for possible mandated divestitures, officials said on Wednesday.

The EU executive has already approved restructuring plans for British lender Lloyds Banking , Dutch financial group ING Groep NV and Belgian group KBC .

Giving break-up power to regulators would be a good thing, said Paul Miller, a policy analyst at investment firm FBR Capital Markets, on Wednesday.

Big banks in general are bad for the economy because they do not allocate credit well, especially to small businesses, he said. Eventually the big banks get broken up in one way or another, Miller said at the Reuters Global Finance Summit.

It's still an extreme position, but it's building consensus probably faster than most people think.

(Additional reporting by Karey Wutkowski in New York; Editing by Chizu Nomiyama)

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