Lawmakers on Thursday agreed to boost banks' capital requirements and neared agreement on a derivatives crackdown as they closed in on a historic overhaul of financial regulations.

Lawmakers resolved some sticking points as they hammered out a final version of the bill, but they had yet to tackle controversial proposals that would ban banks' proprietary trading activities and force them to spin off lucrative swaps-dealing operations.

The cartoons are over, we're about to get into the double feature, a tousled Representative Barney Frank said as the committee recessed before tackling the toughest issues.

Frank and other Democrats in charge of the process look likely to retain restrictions on trading and investment activities by banks that could lower revenues by billions of dollars.

But with a self-imposed deadline of Thursday evening closing in, last-minute deal-making could lead to exemptions for mutual funds, manufacturers and other business interests.

The broadest rewrite of Wall Street rules since the 1930s -- nearly 2,000 pages in all -- aims to avoid a repeat of the 2007-2009 financial crisis that plunged the global economy into a deep recession and led to taxpayer bailouts of troubled banks.

Passage of the bill would give Democrats an important legislative victory, alongside healthcare reform, ahead of congressional elections in November.

Success would also allow President Barack Obama to hold up the legislation as a model for other economic powers weighing reforms at this weekend's meeting of the Group of 20 nations in Canada.

Europe's efforts to present a united front on regulation hit a roadblock on Thursday when lawmakers and diplomats failed to agree on new hedge fund rules.

But on Wall Street the prospect of tough new rules sent U.S. bank stocks lower, helping to pull down the overall market. The KBW banks index was off 2.29 percent in late afternoon.

In a wood-paneled chamber on Capitol Hill, interns distributed peanuts as lawmakers flipped through stacks of paper piled in front of them. Frank, chairman of the panel, looked as unkempt as the staffers who had worked through the night.

Lawmakers agreed to raise banks' capital requirements to help them ride out future crises. They also agreed to let regulators set higher standards of duty for broker-dealers who give financial advice.

TOO BIG OR TOO LITTLE?

Democrats hope Obama can sign the reforms into law by July 4, but the final package must first win approval in both chambers of Congress, where the votes of both liberal House Democrats and moderate Senate Republicans will be needed.

There are two very strong criticisms of this bill: one that it is too big and the other that it is too little, Frank said.

Wall Street lobbyists have been unable to kill the overhaul with Democrats riding a wave of public disgust at bank bailouts and bonuses. Some 73 percent of Americans support strong financial reforms, according to a Lake Research Partners poll touted by Democrats on Thursday.

Still, members of the committee are likely to soften their toughest proposals.

Dodd said he was prepared to accept the overwhelming majority of tweaks suggested by his House counterparts to the derivatives crackdown, though he did not say which ones.

House lawmakers have proposed 110 changes to the law that could benefit a wide range of players, from manufacturers like Caterpillar to dominant futures-exchange operator CME Group.

The crackdown would force much trading activity onto exchanges and clearinghouses in a bid to tame a $615 trillion market that exacerbated the financial crisis and led to a $182 billion taxpayer bailout of insurance giant AIG.

SWAPS SPIN-OFF UNRESOLVED

Still unresolved was a controversial provision backed by Democratic Senator Blanche Lincoln to force banks to spin off swaps-dealing operations into separately capitalized units.

At least 81 House Democrats have objected to that measure and could vote against the final bill if the plan is included. One plan being circulated in the afternoon would require banks to only spin off their dealing in highly structured swaps, but it was unclear whether it had any traction.

Under the deal reached on bank capital, banks would have five years to meet the new higher requirements, and those with less than $15 billion in assets would be exempt.

Some $118 billion in bank assets would not count toward the new capital requirements, according to Moody's.

Like Lincoln's proposal, that measure is championed by another Senate centrist whose vote will be needed to pass the final bill -- Republican Susan Collins of Maine.

Another moderate Republican, Senator Scott Brown, was at the center of efforts to weaken the Volcker rule -- the ban on banks' proprietary trading first proposed by White House economic adviser Paul Volcker, according to aides.

Brown was poised to win carve-outs sought by mutual funds, insurers and banks in his home state of Massachusetts.

(Additional reporting by Roberta Rampton, Kim Dixon, Rachelle Younglai and Charles Abbott in Washington and Leah Schnurr in New York; writing by Andy Sullivan; Editing by Andrea Ricci)

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