LONDON - A deal reached by European Union leaders broke a deadlock on bank supervision reform on Friday, overcoming British reservations, but leaving much detail still be worked out in practice.

At a summit in Brussels, the leaders backed preliminary plans to set up a new cross-border system of supervision that would plug gaps highlighted by the credit crunch and help restore confidence among investors.

Lobby groups were relieved a bitter, drawn-out spat has been avoided for now, particularly as Britain is also trying to water down separate EU plans to regulate hedge funds.

We welcome the agreement and the fact we can move on and try to get this system in place, said Patrik Karlsson, a director at the British Bankers' Association.

The United States also put forward plans this week to revamp supervision as part of global efforts to spot risk in financial systems earlier in the hope of avoiding the need to shore up banks at huge costs to taxpayers. Those plans may face a rougher ride among lawmakers.

Officials said the two key compromises agreed with Britain on Friday still left the overall reform largely intact with the ECB keeping a central, enhanced role and leaving the bulk of EU financial rules still subject to binding decisions.

Under the EU proposals, a new European Systemic Risk Board will be set up, hosted by the European Central Bank to issue non-binding warnings about risks.

Britain and national banking and insurance regulators in the EU oppose the ECB chairing the new board, saying this would give it too much sway. The Brussels summit agreed to soften this by having the chair elected by the ECB's Governing Council.

Three new pan-EU supervisory authorities would have binding powers to bring in line a member state that strays from the bloc's insurance, securities and bank rules.

After lobbying by Britain, EU leaders agreed there could be no binding decisions that impinge in any way on the fiscal responsibilities of member states -- for example by forcing a bank bail out.

This is broadly in line with what the ABI has been calling for even with this nod to the British on fiscal responsibility, said Peter Vipond, director of financial regulation at the Association of British Insurers which represent a large block of investors.

LITTLE CHOICE

The binding mechanism will ensure local regulators can't top up EU rules to stop financial firms from elsewhere in the bloc offering their services, Vipond said.

We do believe this will not work without some sort of binding mechanism, that is both necessary and required. We are delighted it is still in there, Vipond said.

Britain had little choice but to swallow the reform with only a few changes as the only allies it could muster were Slovakia, Slovenia and Romania, too few to represent a blocking minority. Heavyweights France, Germany and Italy see now a golden opportunity for such a major reform.

Prime Minister Gordon Brown seems to have conceded a few points but seems to have kept the fiscal responsibility point, Karlsson said.

There were some changes that had to be made to the current system but we did share the UK Treasury's concerns for this link between supervisory and fiscal responsibility, Karlsson said.

The EU's executive European Commission will draft laws to put the new system into place during 2010. Approval from EU states and the European Parliament is needed for final adoption.

The Commission will list examples of where there can be no binding decisions but this won't be an easy task.

Whether fiscal responsibility can be ring fenced is something else, Karlsson said.

If there is a dispute on just the interpretation of an EU rule, that should be fine for there to be a binding mediation but it applies to the capital requirements of a bank, then our members would be concerned about this, Karlsson said.

There is also the question of whether the binding mechanism is applied only to EU financial rules adopted once the new supervisory system is in place or whether existing rules will be amended so they are also included.

(Reporting by Huw Jones, editing by Patrick Graham)

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