A bipartisan agreement on financial regulation reform was close at hand on Thursday in the Senate, with lawmakers working to overcome a key obstacle -- creating a new financial consumer watchdog.

In a sign that serious deal-making was finally getting under way, a Senate aide told Reuters that the two leaders of the Senate Banking Committee were talking again on an issue that is a major priority of the Obama administration.

Democratic Senator Christopher Dodd, committee chairman, and top committee Republican Senator Richard Shelby met on Wednesday night, Shelby spokesman Jonathan Graffeo said.

The two had reached an impasse earlier in February. Dodd's task of winning Senate passage for a bill would be much eased by a show of support from Shelby.

Senator Shelby and Chairman Dodd met with each other just last night and will continue to seek common ground, Graffeo said. Senator Shelby has said all along that he wants to reach an agreement on substantive and meaningful financial reform.

Dodd hopes to introduce a bill early next week, receive amendments by March 5 and hold a working session during the week of March 8, possibly leading to a committee vote.

More than a year since a severe financial crisis prompted a global push for tighter regulation, most senators concur on the basics of reform -- a better way to deal with big firms in distress that avoids bailouts; sharper detection of risks in the financial system; tougher rules to make banks stronger.

Streamlining the federal bank supervision bureaucracy and writing rules for the unpoliced over-the-counter derivatives market are key goals, as well, in what will be a huge piece of legislation. The financial reform bill approved in December by the U.S. House of Representatives was 1,279 pages long.

60-PCT ODDS OF COMPLETION

The odds of Congress sending a comprehensive bill to President Barack Obama's desk to be enacted into law this year are about 60 percent, said Charles Gabriel, policy analyst at investment advisory firm Capital Alpha Partners LLC.

Moreover, he said, the bill may mitigate, rather than stoke, investor concerns along the way.

Through most of February, Republican Senator Bob Corker, a first-term banking committee member, has carried on discussions with Dodd in Shelby's absence. Dodd and Corker are expected to release a bipartisan compromise bill next week.

Meanwhile, Shelby has been drafting a Republican substitute bill, parts of which are expected to be offered later as amendments to whatever Dodd and Corker produce.

A major stumbling block in the way of agreement has been Obama's proposal to create a Consumer Financial Protection Agency. The CFPA would shield Americans from abusive mortgages, deceptive credit cards and other dodgy financial products.

Republicans and lobbyists for banks and Wall Street have been trying to kill or weaken the proposal, calling it an unwise step that would separate consumer protection from banking supervision. The CFPA also threatens bank profits.

Democrats say the CFPA is needed to protect consumers from shoddy and deceitful financial products like the wave of subprime mortgages that added so much to the real estate bubble that burst in 2007-2008, triggering the crisis.

If we can work out the consumer product deal in some way ... then I believe we'll get together on a bill. If we don't we'll, I guess, be politically estranged, Shelby told reporters after a hearing on Capitol Hill.

CFPA MAY BE A DIVISION

To bridge the divide over consumer protection, Dodd and Corker were likely to recommend that the CFPA be set up as a division of a new bank regulatory agency, rather than an independent agency on its own.

Asked about that after a hearing on Thursday, U.S. Rep. Barney Frank, chairman of the House Financial Services Committee, defended the importance of an independent agency, which the White House favors and which is included in the House bill.

I like what I have, Frank said. If the Republicans want to kill that (an independent CFPA) they should be given a chance to do that with a big public debate.

White House spokeswoman Jen Psaki said: Our top priorities on CFPA are ensuring the bill includes independent appointment, an independent budget, and an independent ability to set and enforce clear rules of road to protect American families.

Treasury Secretary Timothy Geithner met with financial industry lobbyists on Thursday amid signs that they were increasingly willing to talk after many months of stonewall resistance to the Obama administration's proposed reforms.

At a congressional hearing, Federal Reserve Chairman Ben Bernanke poured cold water on the idea of a Volcker rule that would ban banks from engaging in proprietary trading -- using government-guaranteed capital to make bets for their own accounts -- as the Obama administration has advocated.

It would be difficult to do on a purely legislative basis, Bernanke said.

Congress looks unlikely to adopt the rule as proposed, in any case, leaning instead toward empowering regulators, at their discretion, to ban prop trading and other activities at firms judged to pose a risk to financial stability.

(Additional reporting by David Lawder, Caren Bohan, Rachelle Younglai, Glenn Somerville, Tim Ahmann and Karey Wutkowski; Editing by Dan Grebler)

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