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UPDATE 2-EU proposal on bank rules have merit -German watchdog

* Bafin sees advantage in not dismantling universal banks

* EU cannot afford interregnum in supervision -Bafin chief

* Bafin doubtful if banking supervision in place by Jan. 1

(Adds comments) By Edward Taylor and Andreas Kröner

FRANKFURT, Oct 8 (Reuters) - Germany's markets regulator signalled support on Monday for the proposals of an EU advisory group that last week called for banks' deposit-taking business to be legally separated from higher-risk activities.

The advisory group, led by Bank of Finland Governor Erkki Liikanen, called for a separation of riskier activities, including banks' trading on their own behalf as well as "activities closely linked with securities and derivatives."

"Liikanen's approach is very much worth considering," Bafin's chief, Elke Koenig, told reporters on the sidelines of a banking event on Monday.

The proposals are more nuanced than the findings of the Vickers Commission in the UK or the Volcker Rule in the United States, according to Koenig.

One of the attractions of Liikanen's ideas is that they do not seek to dismantle the universal banking model, Koenig added.

"One of the main questions to resolve is whether a bank doing a hedge is doing this for itself or on behalf of a client. I believe this can be defined, but the devil is in the details," said Koenig.

Koenig sharply criticised the lack of progress in setting up a single banking supervisor in the euro zone and cast doubt on next year's deadline.

"I support the idea of a strong European regulator. But I have not seen a roadmap of how we get there," she said, commenting about efforts to centralise banking regulation at a pan-European level.

"My problem is that I don't really see how we can get it done by Jan. 1," Koenig said about the deadline.

Policymakers regard ECB supervision as a pre-requisite for the direct recapitalisation of struggling banks. While this is expected to be in place from early next year, there are differences over what steps need to be in place first.

"The last thing we can afford is to have an interregnum between those who are no longer responsible and those who are not yet in a position to act," Koenig said.

Germany wants to keep oversight of its regional savings and cooperative banks and has long had doubts about the wisdom of direct bank recapitalisation.

It has questioned whether the ECB should spread itself so thinly, preferring the ECB to take charge of major systemic banks, not all 6,000 lenders.

"We need to get it right - we only have one shot," Koenig said.

She declined to say whether Bafin would approve the BHF acquisition by RHJ , nor did she comment on the ongoing Libor probe.

(Writing by Christiaan Hetzner; Editing by Kenneth Barry and Leslie Adler)

((christiaan.hetzner@thomsonreuters.com)(+49 - 69 - 7565 1249)(Reuters Messaging: christiaan.hetzner.thomsonreuters.com@reuters.net))

Keywords: GERMANY BANKS/WATCHDOG