UPDATE 2-SEC, Fed near agreement to oversee financial system

(Adds details from hearing, further comments)

By Rachelle Younglai

WASHINGTON, June 19 (Reuters) - The U.S. Securities and Exchange Commission and the U.S. Federal Reserve have nearly completed a formal agreement to oversee the financial system, an SEC official told a Senate panel on Thursday.

The regulators are working on a memorandum of understanding to outline the scope and mechanism for sharing information related to the Fed's discount window and other areas, Erik Sirri, the SEC's director of trading and markets, said at a hearing to examine risk management in the financial system.

The memo would provide a mechanism for regulators to gain a broader and continuous perspective on financial institutions and markets that could impact the stability of the financial system, Sirri said.

It will also help with "bridging the period of time until Congress can address through legislation" fundamental questions about investment bank supervision, he said.

Lawmakers have been grappling with how the investment banks should be overseen after Bear Stearns nearly collapsed in March when its liquidity dried up.

"Events of the past year have exposed significant fault lines," said Sen. Jack Reed, a Democrat from Rhode Island who chaired the hearing. "Risk management is critical," he said.

Fed Vice Chairman Donald Kohn said supervision of the country's financial system needs to adapt to sophisticated banks and securities firms. He also told Congress that the Fed is mulling the future of a loan window for investment banks, which was opened in March to calm the markets amid the Bear Stearns crisis.

Previously, the investment banks never had access to the window and the access is a temporary measure that is expected to end in September.

The Fed also helped broker a takeover of Bear by JPMorgan Chase (JPM.N). The central bank guaranteed a $29 billion loan backed by taxpayers' money to facilitate the deal on concern that a Bear bankruptcy could trigger a systemic financial failure.

"As institutions grow larger and more complex, we need to ensure that our system of consolidated supervision keeps pace," Kohn said.

Currently, the SEC supervises the four largest investment banks, Goldman Sachs (GS.N), Lehman Brothers LEH.N, Merrill Lynch MER.N and Morgan Stanley (MS.N) for liquidity and capital levels.

But the supervisory program is voluntary. SEC Chairman Christopher Cox has urged Congress to decide which regulator should have primary oversight over the investment banks and to make supervision mandatory.

U.S. Treasury Secretary Henry Paulson has also urged swift action. Paulson said the Fed's role in rescuing Bear Stearns meant lawmakers must examine whether the central bank has the authority and direction it needs to be a lender of last resort when the financial system is threatened.

After the hearing, Reed told reporters it would be difficult to write and approve a law for the supervision of the investment banks in 2008 because of the relatively few legislative days remaining.

"In terms of the legislative schedule, it would be awfully difficult," he said, adding that if regulators feel they need legislation this year, they need to send a legislative proposal quickly.

(Reporting by Rachelle Younglai, additional reporting by Mark Felsenthal; editing by Leslie Gevirtz, Gary Hill)