State banking regulators are asking Congress and the Obama administration to keep states involved in monitoring the most important financial institutions.

Joseph Smith Jr., the North Carolina banking commissioner, testified in favor of making room for state regulators today during a hearing on Obama administration financial services proposals that was organized by the House Financial Services Committee.

The Obama administration has proposed creating a Financial Services Oversight Council that would include all current federal financial services regulators and would have jurisdiction over all “Tier 1 financial holding companies” — financial holding companies that are so large or so tightly woven into the fabric of the economy that their failure could bring down the financial system.

Smith, who appeared on behalf of the Conference of State Bank Supervisors, Washington, said state regulators are often the first to spot emerging trends and threats.

“An oversight council that does not include some mechanism for state involvement will not be informed by this knowledge and proximity,” Smith said.

One way to keep state regulators in the loop would be to equip the proposed FSOC with state liaison committee similar to the state liaison committee that now advises the existing Federal Financial Institutions Examination Council, Smith said.

Several other witnesses emphasized the importance of FSOC having jurisdiction over Tier 1 insurance companies.

“The current financial crisis has clearly demonstrated that risks to the financial system can arise not only in the banking sector, but also from the activities of other financial firms–such as investment banks or insurance organizations–that traditionally have not been subject, either by law or in practice, to the type of regulation and consolidated supervision applicable to bank holding companies,” Federal Reserve Chairman Ben Bernanke testified.

“While effective consolidated supervision of potentially systemic firms is not, by itself, sufficient to foster financial stability, it certainly is a necessary condition,” Bernanke said.

Treasury Secretary Timothy Geithner said the Obama administration wants to make sure “systemically important” firms that sought government help in recent months continue to be subject to government attention.

The administration’s proposal would “prevent systemically important firms that have become bank holding companies during the crisis from reversing this change and escaping prudential supervision in calmer financial times,” Geithner said.

More information about the hearing, including links to the written versions of the witnesses’ testimony, is available here.