A U.S. lawmaker charged with a key role in hammering out a final financial regulation bill said on Tuesday there is no need to force banks out of the lucrative over-the-counter derivatives business -- a potentially big win for Wall Street firms.

Barney Frank, the Democratic congressman named to chair the House-Senate panel that will craft the final bill, said he disagreed with language in the Senate's bill that could force banks to spin off their derivatives trading desks.

Banks should be allowed to use derivatives, Frank, chairman of the House of Representatives Financial Services Committee, said at an event in Washington.

New rules for the $615 trillion over-the-counter derivatives business are one of the most contentious parts of the broad regulation bill. One veteran banking analyst has said the legislation, including new derivatives rules, could lower the banking industry's earning capacity by about 25 percent.

The Senate bill aims to curb banks' risky activities by forcing banks to choose between their derivatives business and access to the Federal Reserve's emergency funds and other federal protections. Those provisions were proposed by Senator Blanche Lincoln, who said it would ensure that banks get back to the business of banking.

Michael Holland, a money manager with Holland & Co, said Frank's opposition to Lincoln's provision will carry a lot of weight because Frank himself has a reputation as a critic of Wall Street.

If the chief punisher and chief critic thinks derivatives are OK, it is bye-bye Blanche Lincoln, Holland said.

OTC derivatives are currently traded in private, mostly among a handful of Wall Street firms, including Goldman Sachs, JPMorgan Chase, Bank of America, Morgan Stanley and Wells Fargo.

Lincoln, a Democrat who is fighting a tough reelection campaign in Arkansas, has stuck by her tough-on-Wall-Street proposal despite opposition from the Federal Deposit Insurance Corp and the U.S. Federal Reserve.

Both contend that some of banks' riskiest activities would move out of the purview of federal regulation.

Lauren Teigland-Hunt, a derivatives lawyer in New York said Frank's comments were incredibly refreshing.

It wasn't clear what problem Lincoln was trying to solve -- it seemed like a not-well-conceived measure that had potentially adverse consequences for the U.S. banking industry, she said.

VOLCKER RULE SUFFICIENT

Frank said he believed another proposed restriction -- the so-called Volcker rule that aims to prohibit banks' proprietary trading -- was sufficient to limit banks' risky activities.

A watered-down version of the Volcker rule is included in the Senate bill, but was not in the House version that passed in December. Frank said he believed the Volcker rule would be included in the final regulation bill.

I think that will be adopted, Frank said.

The rule would restrict banks from proprietary trading, or the buying and selling of investments on their own books unrelated to customer needs. Banks would also be barred from sponsoring or investing in hedge funds and private equity funds, under the administration's language.

Frank's House-Senate panel is expected to start ironing out differences between the two bills after panel conferees have been chosen.

Frank said he expected the two chambers to reconcile their differences and have a bill ready for President Barack Obama to sign by early July.

(Additional reporting by Joseph Rauch and Dan Wilchins; Editing by Andrea Ricci and Leslie Adler)

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