* UK lays out concerns on banking union
* Fears ECB will dominate supervisory decisions
* Protectionism still a risk
* Warned against trading monopolies
(Adds detail on banking union)
By Claire Davenport
BRUSSELS, Oct 3 (Reuters) - Britain warned on Wednesday it would be unacceptable for the European Central Bank to have too dominant a role in a new system of supervision designed to watch over the region's banks.
Brussels proposed earlier this month that the ECB take charge of supervising all banks in the euro currency zone, as a first step towards creating a banking union under which euro zone countries would eventually jointly back their lenders.
"We have concerns on the current banking union proposal especially the potential for the ECB to dominate decisions," UK financial services minister Greg Clark told reporters.
"As things stand there is an unacceptable risk that the ECB could dominate to an extent that I don't think was envisaged."
Clark made the remarks before meeting the European Union's commissioner in charge of regulation, Michel Barnier, to discuss his concerns.
While Britain will stay outside the scheme, many international banks in London - ranging from HSBC to Citi - have operations in the euro zone that will be affected by the ECB's new supervisory reach.
London is worried that the ECB, emboldened by its new powers, will demand regulation that could undermine the City's position as Europe's financial capital.
Some believe the European Banking Authority (EBA), set up to coordinate the supervision of banks in response to the financial crisis and which is run by regulators from across the European Union, could act as a counterbalance.
The European Commission has already suggested a special voting mechanism among EU regulators as a counterweight to the power of those in the euro zone.
But Britain is still worried that its financial regulator could be subject to ECB decisions under a banking union even where it disputes the decision.
The EBA has the power to resolve disputes between national regulators, but Britain worries the ECB, an independent body under the EU's Treaty, could be exempt.
Clark warned that even if safeguards were put in place there was a risk any new rules may not be respected.
"Protectionism and fraying of high-minded agreements is always possible especially when times are difficult," he said.
"It's important we withstand that." RESTORING CONFIDENCE
The planned banking union, which would aim to restore confidence in an industry that has been battered by crisis for nearly five years, involves three major steps.
The ECB would take over monitoring euro zone banks and others that sign up, a single fund would be created to close down and settle the debts of failed banks, and a comprehensive scheme to protect savers' deposits would be established.
As well as building the foundation for better control of banks, the banking union would allow the euro zone's rescue fund, the European Stability Mechanism (ESM), to inject much-needed capital into banks, such as those in Spain.
The close ties between some troubled governments and the banks they supervise - and on which they also rely to buy their debt - have dragged both deeper into crisis.
A banking union would break this link by making the policing of banks supranational and establishing central schemes paid into collectively to cover the costs of closing failed lenders and protecting savers' deposits.
In separate speech on Wednesday, Clark also criticised proposals to regulate EU markets known as Mifid that would force banks to channel derivatives contracts worth trillions of euros through clearing houses to improve safety and transparency.
European parliament lawmakers voted last week to water down articles in the draft law intended to increase competition in derivatives clearing, which Clark said would leave market users with little or no choice of where to settle their trades.
"Do we wish to legally mandate in Mifid that one or two monopolies govern our market infrastructure with all the inefficiencies that this brings?" he said, calling for radical reform to foster competition in EU financial markets.
Finance ministers of the 27 EU states, which have a joint say on Mifid, are due to debate it in early October, when Britain will try to persuade them to amend the draft law.
(Additional reporting by Huw Jones in London; Editing by Catherine Evans, Barbara Lewis)
Keywords: BRITAIN EU/MARKETS