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 regulatorsignalled support on Monday for the proposals of an EU advisorygroup that last week called for banks' deposit-taking businessto be legally separated from higher-risk activities.

The advisory group, led by Bank of Finland Governor ErkkiLiikanen, 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 abanking event on Monday.

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

One of the attractions of Liikanen's ideas is that they donot seek to dismantle the universal banking model, Koenig added.

"One of the main questions to resolve is whether a bankdoing 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 upa single banking supervisor in the euro zone and cast doubt onnext year's deadline.

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

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

Policymakers regard ECB supervision as a pre-requisite forthe direct recapitalisation of struggling banks. While this isexpected to be in place from early next year, there aredifferences over what steps need to be in place first.

"The last thing we can afford is to have an interregnumbetween those who are no longer responsible and those who arenot yet in a position to act," Koenig said.

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

It has questioned whether the ECB should spread itself sothinly, preferring the ECB to take charge of major systemicbanks, not all 6,000 lenders.

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

She declined to say whether Bafin would approve the BHFacquisition by RHJ , nor did she comment on the ongoingLibor probe.

(Writing by Christiaan Hetzner; Editing by Kenneth Barry andLeslie Adler)

((christiaan.hetzner@thomsonreuters.com)(+49 - 69 - 75651249)(Reuters Messaging:christiaan.hetzner.thomsonreuters.com@reuters.net))