A reserve fund must be established ahead of time to give the government the working capital it needs to dismantle large, troubled financial companies, a top U.S. bank regulator said on Tuesday.

Sheila Bair, chairman of the Federal Deposit Insurance Corp, said she opposes the proposal by the Obama administration and a leading senator to collect fees from financial companies after another firm is seized and dismantled.

This would not be a bail-out fund. This would not be an insurance fund, Bair said in prepared remarks to the Institute of International Bankers. It would provide short-term liquidity to maintain essential operations of the institution as it is broken up and sold off.

Senate Banking Committee Chairman Christopher Dodd earlier on Tuesday released draft legislation that calls for any government expenses to be recouped after a financial company fails and is liquidated. The FDIC would be in charge of dismantling the company.

Treasury Secretary Timothy Geithner has been adamant that creating a standing fund would enhance moral hazard and be viewed by the financial industry as an insurance fund that would insulate it from risky bets.

Bair, however, has been successful in convincing Representative Barney Frank to reverse his opinion on the topic. He recently said he now supports pre-funding the so-called resolution authority.

The resolution authority is just one piece of sweeping legislation moving through Congress to overhaul financial regulation. Other pieces include creating a new consumer agency to police financial products, consolidating bank regulators and creating a new council to oversee risks to the financial system.

The House has made considerably more progress through public bill-writing sessions and hopes to have a full House vote by early December.

The Senate Banking Committee will start drafting formal language and consider amendments in early December, Dodd said on Tuesday. He did not estimate when the full Senate might vote.

Bair said during her remarks on Tuesday that Frank, chairman of the House Financial Services Committee, is going to take other measures to strengthen his version of financial reform.

She said he will eliminate the government's ability to assist open but troubled financial companies, will ban the government from investing capital in those institutions, and will create a higher standard for the FDIC and Federal Reserve to provide support to healthy companies in the event of a systemic meltdown.

We've had too many years of unfettered risk-taking, and too many years of government-subsidized risk, Bair said. It's time we closed the book on the doctrine of too big to fail.

Bair also said regulators can restrain risk in the system by ensuring that large financial companies hold high amounts of capital. She said recent improvements in market conditions cannot deter the effort to follow through on tough new capital standards.

There is little doubt that there will be eye-popping reductions in required capital when the good times return to banking, she said.

(Reporting by Karey Wutkowski in Washington and Clare Baldwin in New York, Editing by Andrea Ricci and Gerald E. McCormick)

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