Bipartisan agreement in the Senate on financial reform hit a snag on how much power to give a consumer watchdog office being proposed by Democrats, with marathon talks resuming on Sunday.

The legal fine points of the dispute were obscure, but aides said key lawmakers remained hopeful that a deal can be worked out on an issue that is one of President Barack Obama's top domestic policy priorities.

Senator Bob Corker, a Tennessee Republican, for weeks has kept talking with Senate Banking Committee Chairman Christopher Dodd on reform. The panel's top Republican, Senator Richard Shelby, in recent days rejoined negotiations amid a new sense of urgency.

Senator Corker continues to be optimistic that we will be successful in getting a good piece of regulatory reform legislation, said an aide, Laura Herzog.

Nearly a year and a half since a severe financial crisis tipped the economy into its worst recession in decades, financial regulation has changed little, despite repeated assertions that reform is critical to avoiding another crisis in the future.

For Congress, time is running short. Midterm elections are approaching in early November. Between now and then, Congress will be in session for perhaps 23 weeks.

In that timeframe, a bill would have to move out of the banking committee, be debated and voted on the Senate floor and, if passed, reconciled with the bill already passed by the House of Representatives.

Democrats are keen to see a bill sent to Obama for signing before the November elections, and many Republicans increasingly sense they should not block the efforts on reform.

The calendar is starting to become a factor, said Brian Gardner, a policy analyst at investment firm Keefe Bruyette & Woods. All in all, I think the banking committee is headed toward getting a bill done before the end of the year.

BILL MAY NARROW

The struggle in the Senate suggested to some that new legislation -- which many still expect from Dodd next week -- may be narrower in scope than Obama's proposals of nine months ago, and the sweeping bill passed by the House in December.

They're going to push real hard to get something out next week, Gardner said. There's a chance that it could be a little bit smaller than the House bill and Obama's proposals.

Provisions that may be dropped could include over-the-counter derivatives regulation, as well as proposals to give shareholders more say in electing corporate directors and determining corporate executive pay, Gardner said.

One of Dodd's boldest proposals from a November draft bill -- to consolidate the patchwork banking supervision system into one agency -- was unlikely to make it into the committee's final bill, a source familiar with negotiations told Reuters.

Sources told Reuters on Saturday that neither Democrats nor Republicans had embraced Dodd's offer on Friday to scale back Obama's proposed Consumer Financial Protection Agency.

Dodd had circulated a proposal to make the consumer protection agency a division of the Treasury Department, instead of an independent agency, which Obama recommended. But in a setback for Dodd, his offer was rejected by Corker and Shelby, sources said.

The sources said Shelby and Corker objected to the rule-writing power Dodd proposed for the consumer division, but not necessarily to the idea of the division itself being located in the Treasury Department or another federal agency.

On the opposite side of the consumer watchdog issue, many Democrats were still holding out for an independent agency, said lobbyists and aides close to the talks.

In our view, this language will change considerably before the bill advances to the floor of the Senate, said Jaret Seiberg, financial services policy analyst at investment advisory firm Concept Capital.

(Editing by Leslie Adler)

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