* Drivers to be offer trade-in incentives or hardware fix
* Industry favours trade-ins as solution
* Comes as some German cities ban older diesel models (Adds Daimler, BMW responses)
BERLIN, Oct 2 (Reuters) - The German government presented plans to cut pollution from diesel vehicles by asking carmakers to offer owners trade-in incentives and hardware fixes, prompting objections from environmental groups and grudging concessions from the industry.
After marathon talks, Chancellor Angela Merkel and leaders of her coalition partners announced in the early hours of Tuesday they had agreed on a way to cut pollution in the worst-affected German cities while avoiding unpopular driving bans.
Owners of millions of older diesel vehicles in Germany's 14 most polluted cities should be able to choose between trade-in sweeteners and hardware upgrades for their vehicles.
Carmakers, however, did not all commit to covering the cost of retrofits, as the hardware fixes are known, which could run into billions of euros.
They said instead the focus should be on encouraging car owners to trade in their older diesel models for cleaner vehicles - which would bring a boost in sales, albeit at discounted prices.
Daimler gave arguably the strongest backing, saying it was prepared to participate in the retrofit programme and offering incentives of up to 10,000 euros ($11,564) for those swapping old cars for new Mercedes models.
"We are convinced that emissions of nitrogen oxide can be controlled in cities with modern diesel and without driving bans," said Daimler CEO Dieter Zetsche, referring to diesel byproducts that can cause respiratory ailments.
BMW also said it would offer a trade-in incentive of 6,000 euros in the most polluted parts of the country.
France's Renault said earlier on Tuesday it was offering owners of older diesel vehicles in Germany incentives of up to 10,000 euros if they bought new cars.
However, the chief executive of France's PSA Group said the retrofit approach "doesn't work", although the trade-in approach was more viable.
"Who's going to pay is not clear. We believe it's not the carmakers' responsibility because at the time when those cars were sold they met all legal requirements," Carlos Tavares told Reuters at the Paris Motor Show.
The government cannot force the carmakers to pay for hardware upgrades, but shares an interest with the industry in preventing further driving bans for polluting cars, which have already been imposed in Hamburg and are planned for Frankfurt and Stuttgart, the home of Germany's car industry.
On the other side of the argument, green groups argued that the government should have been tougher on the industry, three years after the "dieselgate" scandal broke out at Volkswagen.
Volkswagen's admission in 2015 that it cheated U.S. diesel emissions tests led to the discovery that diesel vehicles from several manufacturers routinely exceeded pollution limits in normal driving conditions, prompting a regulatory crackdown.
Environmental groups have been heartened by a court ruling in February that allowed cities to ban older diesel cars.
"Driving bans will not be avoided with this double failure to come up with a solution," said Juergen Resch, managing director of environmental group DUH, noting upcoming rulings in a number of major cities.
Ministers were keen to trumpet a deal that they said would mean a big investment by carmakers in getting drivers into cleaner cars.
"We are talking about a significant billion (euro) contribution that German carmakers will bring for these models," Transport Minister Andreas Scheuer said.
German Environment Minister Svenja Schulze said that the car industry should take the chance of avoiding driving bans.
"My impression is that the car industry has a big interest in restoring the image of diesel," she said.
Carmakers have said they expect only a small proportion of owners of the affected vehicles to opt for a retrofit rather than a trade-in, and raised practical objections over the plan.
Volkswagen said whether retrofits were possible would depend on suppliers developing systems that were good enough, and it did not commit to covering the cost of hardware upgrades.
Costs for the industry could be as high as 12.5 billion euros, estimated Stefan Bratzel, director of Germany's Center of Automotive Management.
"If around 2.5 million vehicles take up retrofits or trade-in incentives with costs between 2,500 and 5,000 euros, the total cost would be between 6.3 and 12.5 billion euros," he said.
There are 3.1 million diesel cars running to the Euro 4 standard, and 5.7 million Euro 5 diesels, out of a total of 46.5 million cars on the roads in Germany, according to figures from the German KBA transport authority.
END OF THE ROAD?
Environmental group Greenpeace accused the industry of exploiting the situation.
"The carmakers are trying to turn their cheating on emissions into a sales bonanza for new cars - a strategy that will continue to damage the climate and waste resources," it said.
Klaus Mueller, head of Germany's Consumer Protection Association told the Sueddeutsche newspaper that many customers would not be able to afford to change their cars even with the trade-in incentives.
The proposals apply to diesel vehicles meeting the older Euro 4 and Euro 5 emissions standards. The current standard is Euro 6.
Some leading figures in the industry saw diesel vehicles being phased out over time.
"We are obviously headed for the end of diesel," Renault Nissan Chief Executive Carlos Ghosn told reporters at the Paris auto show where electric cars are in the spotlight.
"Its the end of the game," he added. ($1 = 0.8648 euros) (Additional reporting by Douglas Busvine in Frankfurt and Joe White and Laurence Frost in Paris Writing by Michelle Martin, Madeline Chambers and Keith Weir Editing by Maria Sheahan and Georgina Prodhan)