By Dave Clarke

WASHINGTON (Reuters) - Banks may get breathing room on the Volcker rule's looming crackdown on proprietary trading, after a Federal Reserve official pledged to ease firms into compliance and Representative Barney Frank asked regulators to scrap their original proposal in favor of a simpler approach.

U.S. regulators have said they will likely miss a July deadline to finalize the controversial trading ban that threatens to limit Wall Street's profit potential.

Banks have raised concerns that if a rule is not ready by July 21, when the controversial trading restriction takes effect under law, there could be disruptions in markets because of a lack of clarity on how to comply with the crackdown.

They have also complained regulators' first proposal was too complex and simply unworkable.

"There is obviously a real possibility that we don't meet the July 21st date," Fed Governor Daniel Tarullo told a Senate Banking Committee hearing.

"If we are not going to, I think it is incumbent on all the regulators to provide some guidance for firms to let them know exactly what the expectations will be and not let this hang out there as an unknown, and I think we should be able to do that if needed," he said.

Separately, Frank, a co-author of the 2010 Dodd-Frank financial oversight law, called on regulators to issue a simplified version of the Volcker rule by September 3.

He argued that the initial proposal released in October was "far too complex."

Frank, in a statement, also said regulators should issue clear guidance on what they expect from banks in the period of time between the July deadline and when the final rule is released.

The Volcker rule, included in the Dodd-Frank law, bans banks from trading with their own funds and greatly limits their ability to invest in hedge and private equity funds.

The idea is to limit excessive risk-taking by banks that enjoy government backstops such as deposit insurance and access to Fed loans.

The Volcker rule is expected to have the most impact on Wall Street firms including Goldman Sachs Group Inc and Morgan Stanley that have made significant profits betting with their own money.

Regulators' October proposal was roughly 300 pages, with hundreds of questions for public comment, indicating the final version could look significantly different.

Supporters of the trading restrictions have blamed Wall Street lobbyists for making a simple premise more complex when they convinced lawmakers to add exemptions and other changes meant to dull the crackdown's impact.

Frank, however, said the complexity has become problematic as regulators try to find an answer to every quibble.

"The agencies tried to accommodate a variety of views on the implementation but the results reflected in the proposed rule are far too complex, and the final rules should be simplified significantly," he said in a statement.

Frank urged regulators and banks to take a step back and use a two-year transition period laid out in the law to "learn from actual experience and make appropriate adjustments in the enforcement regime."

Frank is the top Democrat on the House Financial Services Committee, and he is retiring from Congress at the end of the year.

TRANSITION PERIOD

Banks want more than assurances of guidance if the deadline is missed. On Thursday, Republican Senator Mike Crapo introduced legislation along with two other Republicans and three Democrats that would delay implementation of the Volcker rule until release of a final rule.

But Tarullo told Crapo he did not think legislation was needed.

Tarullo said the guidance should be enough and said the Fed can also provide more clarity on what regulators will expect during the two-year transition period as well.

"I think we can deal with both issues here without legislation and we will try to go ahead and do so," Tarullo said.

AVOIDING U.S. RULES

Tarullo also told the committee that the Fed will look at how foreign banks in the United States are regulated after Deutsche Bank AG changed the legal status of its main U.S. subsidiary in order to avoid injecting billions of dollars of capital into the unit.

When asked whether Deutsche's decision would have an impact on the health of the financial system, Tarullo said he thought the Fed would need to respond.

"The development to which you just alluded has certainly affected my thinking of how we do structured regulation of foreign bank organizations, and I think we will need to respond to that," Tarullo said.

Deutsche Bank declined to comment.

(Reporting By Sarah N. Lynch, Dave Clarke, Rachelle Younglai in Washington and Edward Taylor in Frankfurt; Editing by Gerald E. McCormick, Matthew Lewis and Tim Dobbyn)