Bipartisan efforts on Capitol Hill to tighten financial regulation ground to a halt in the Senate on Friday, casting one of the top domestic policy priorities of the Obama administration in a stark political light.

After months of public debate and closed-door talks, Senate Banking Committee Chairman Christopher Dodd, the Democrats' chief negotiator, said he has been unable to agree on a bill with his Republican counterpart, Senator Richard Shelby.

We have reached an impasse, Dodd said, adding he is drafting new legislation to be considered later this month. While I still hope that we will ultimately have a consensus package, it is time to move the process forward.

The situation leaves Democrats to proceed alone on an initiative of international significance since the 2008 financial crisis, while painting Republicans -- allied with banks and Wall Street -- into an uncomfortable obstructionist corner.

At stake is President Barack Obama's push for tighter oversight of the politically unpopular financial industry -- an initiative that rose to the top of his agenda after an embarrassing election defeat in January for Democrats in Massachusetts.

The Senate impasse comes as finance ministers for the Group of Seven rich nations meet this weekend in Canada, with financial regulation high on their agenda.

The main obstacle to Senate agreement is Obama's proposal to create a Consumer Financial Protection Agency (CFPA) to protect Americans from abusive mortgages and credit cards. Banks oppose the agency as a threat to their profitability.

Republicans say the CFPA would be a costly new layer of government bureaucracy while Democrats say it is needed because existing agencies failed to enforce consumer protection laws already on the books, contributing to the financial crisis.

FRANK BACKS DODD

Democratic Representative Barney Frank said that by declaring an impasse, Dodd will speed movement toward a vote and force the hand of Republicans who have opposed reforms for more than a year, in line with bank lobbyists.

Chris is forcing the pace here. He gave them plenty of time, but at some point, people are going to have to vote on this. It's going to be a test of the Republicans, said Frank, the chairman of the House of Representatives Financial Services Committee, in an interview with Reuters on Friday.

In addition to the CFPA, Democrats want a new regulator to police systemic risk in the financial system, new procedures for dealing with large financial firms in distress and new protections for investors and financial consumers.

Shelby said in a statement he was willing to work with Democrats, but added that some topics were non-negotiable, such as the CFPA, which would strip existing bank supervisory agencies of their consumer protection responsibilities.

I fully support enhancing both consumer protection and safety and soundness regulation, he said. I will not support a bill that enhances one at the expense of the other, however.

Elizabeth Warren, a Harvard Law School professor seen as frontrunner to head the CFPA, told Reuters the breakdown of negotiations was a testament to the power of Wall Street.

Even after 16 months of pain, a few basic, common sense safety rules are somehow controversial, said Warren, who now chairs a watchdog panel overseeing the $700 billion financial bailout program established during the waning days of the Bush administration.

Dodd said that some bipartisan agreements are close to being reached and he hopes to include them in a new proposal.

Republican Senator Bob Corker said he was disappointed with the Dodd-Shelby impasse, but added he and Democratic Senator Mark Warner were close to a bipartisan approach to systemic risk regulation and dealing with big troubled firms.

Republican Senator Judd Gregg said he remains committed to working with Dodd, Shelby and Senator Jack Reed with whom he has had constructive dialogue on derivatives market reform.

FRANK SEES BILL BY SUMMER

Frank said he is still confident there will be a House-Senate conference before summer to agree on a single bill to send to Obama. What Senator Dodd is doing is perfectly reasonable on all fronts, Frank said.

The House in December approved a bill calling for the biggest financial regulatory changes since the Great Depression. Lobbyists for banks and Wall Street firms fought the bill for months and all House Republicans voted against it.

The Senate has been debating the matter for more than a year. While Republicans have conceded that regulatory changes are needed, they have not offered a comprehensive strategy of their own and have consistently opposed Democratic measures.

As the debate has worn on, public anger over bailouts of financial firms, and big executive bonuses, has grown. As November elections near, Democrats are seeking to portray Republicans as obstacles to reform and allies of Wall Street.

Democrats suffered a blow in January with the loss of a special Senate election in Massachusetts. That reduced their voting bloc in the Senate by one, making passage of a financial reform bill dependent upon winning some Republican support.

Neal Wolin, U.S. Treasury Department Deputy Secretary, said in a statement: Enacting comprehensive financial reform remains an urgent priority and we believe it is important that the process move forward.

A Senate Banking subcommittee has scheduled a hearing for Wednesday on equipping regulators to monitor systemic risk, with Federal Reserve Governor Daniel Tarullo testifying.

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