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* EU finance ministers back reform of financial supervision

* Britain against loss of supervisory sovereignty

* Commission to draft outline proposals by mid-May

* EU's McCreevy said tough talks lie ahead

(Adds news conference, Steinbrueck)

By Huw Jones and Anna Willard

PRAGUE, April 4 (Reuters) - Britain clashed with its European Union partners on Saturday over an ambitious reform of financial supervision that would erode its sovereignty in regulating the bloc's biggest financial centre.

The UK is fiercely protective of its City of London financial sector which is a major tax contributor, but France and Germany want stronger supervision of large financial institutions operating across EU borders to prevent a future banking crisis that could damage the 27-nation bloc.

"We agreed we have to reinforce the European supervisory structure but there will still be a very demanding discussion on the final model to be adopted," said Miroslav Kalousek, finance minister for the Czech EU presidency.

Britain was largely isolated because of its two fundamental reservations over reform while the bulk of member states said they wanted to push ahead based on a plan from former Bank of France governor Jacques De Larosiere.

There is no sign of Britain being outvoted for now.

"We need to find a common front, a common solution, because we cannot leave Britain outside the system. London plays too important a role in the financial arena to be left to one side," French Finance Minister, Christine Lagarde told reporters.

TWO TIER

De Larosiere has proposed a two-level approach that would curb national sovereignty by creating a new pan-EU council chaired by the European Central Bank to monitor system-wide risk and plug a big gap in the current framework.

The pan-EU risk council could formally ask the bloc's finance ministers to take action against a member state whose response to a risk warning from the council is inadequate.

"We are fully in support of the macro prudential body but we don't believe that it should necessarily always be chaired by the president of the ECB," a British official said.
(Reuters)