Large banks would not have to set aside money to cover the cost of liquidating troubled financial firms under an agreement on Wednesday by U.S. lawmakers finalizing a sweeping rewrite of financial regulations.

The agreement resolves a crucial sticking point as lawmakers close in on a final version of the overhaul.

Billions of dollars hang in the balance as Wall Street banks face a turning point with members of a panel negotiating the final bill expected to spell out limits on a range of risky but lucrative trading practices later on Wednesday.

Banks like Goldman Sachs and Citigroup could learn the future of their swaps dealing and proprietary trading activities.

They cannot continue to do business as they were doing, said Representative Barney Frank, the Democrat who is overseeing the process. They have to get back in the business of accumulating capital and making loans to private parties.

As a House-Senate panel sat down for a marathon negotiating session, Frank and other House Democrats proposed a new $4 billion tax on large banks and hedge funds to help unemployed people hold on to their homes.

That is separate from a much larger tax on the industry that Congress could take up later this year.

They also proposed softening a crackdown on the derivatives market by allowing participants to use non-cash collateral to meet margin requirements on their trades. Senate negotiators had yet to weigh in on the proposals.

Democrats hope to resolve differences between bills passed by the Senate and the House of Representatives by the end of the week, when President Barack Obama heads to Canada to discuss financial reforms with other leaders of the G20 economic powers.

Democrats are eager to crack down on a deeply unpopular industry after the 2007-2009 financial collapse that touched off a global recession and public bailouts of Wall Street banks. But they have backed off from many of their toughest proposals.

House Democrats on Wednesday said they would drop their plan to require large banks to pay into a $150 billion fund that would cover the costs of unwinding troubled firms. Instead, regulators would cover their costs by selling off the troubled firm's assets and assessing fees on other banks if more money was needed.

The House and Senate must approve the final bill before Obama can sign it into law. Passage would give Democrats a major legislative victory to add to healthcare reform before November's congressional elections.

Bank lobbyists, often working closely with Republicans, have tried to block or water down the bill but have had limited success in the face of widespread voter anger at Wall Street.

TIGHTER 'VOLCKER RULE'

Democratic Senator Christopher Dodd said on Tuesday he will offer a tightened version of a White House proposal known as the Volcker rule that would limit banks trading for their own profits, unrelated to customer needs.

The tightened proposal would limit regulators' ability to waive the proposed ban, but could allow banks to maintain small investments in private equity and hedge funds, according to aides. Banks have pushed hard for the exemption, arguing that it is key to their asset-management business.

House Democrats also offered more than 100 tweaks to a Senate-penned crackdown on the $615 trillion derivatives market, which exacerbated the crisis and forced an expensive bailout of insurance giant AIG.

As it stands, the bill would force banks to spin off their lucrative swaps-dealing operations to ensure that taxpayer-backed deposits are not put at risk.

The sponsor of that provision, Democratic Senator Blanche Lincoln, has since said that banks would be able to house their swaps-dealing operations in a separately capitalized affiliate of their holding company.

Democrats also could tighten Federal Reserve rules to ensure swaps dealing is kept at arms length from bank deposits.

House Democrats did not address Lincoln's proposal in their counteroffer.

Lawmakers also still must spell out which types of end users would be exempt from the tighter derivatives rules.

Republican Senator Mike Johanns said there is almost a resignation here that an overly strict definition will be written. Most of us would like to see an exemption that is broader, he told Reuters in a telephone interview.

Members of the House-Senate panel face a laundry list of other outstanding issues before they can complete their work, which they aim to do on Thursday.

They must resolve the balance of powers between state and federal regulators, and determine which banks would be required to raise their capital reserves -- a pet cause of Senator Susan Collins, one of several moderate Republicans whose support is crucial for passage.

Collins' proposal would not allow banks to count trust-preferred securities, a mix of equity and debt, toward their capital requirements.

House lawmakers want to allow all banks to continue counting their existing trust-preferred securities toward their capital requirements, while Senate lawmakers would only exempt exempt banks with less than $10 billion in assets.

(Additional reporting by Andy Sullivan, Charles Abbott, Roberta Rampton, and Rachelle Younglai; writing by Andy Sullivan)

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