Using Time Machine with WNDR3700 router

Unless there's some restriction on your router, which I doubt, FAT32 has no trouble with volumes over 32GB (of course, it's easy enough to try and confirm this for yourself, since formatting should only take 20 or 30 seconds).

What FAT32 does have is a limit of 4GB per individual file. Time Machine over the network uses sparsebundle images, however, which should bypass this limitation--they're actually a collection of many smaller files, though it appears as one disk image file to you when working with it.

That said, I wouldn't do what you're trying to do; wireless routers, in my experience, are very weak as data serving devices, particularly when it comes to the thousands of small transactions necessary for a Time Machine backup. At worst, this means your backups will be VERY slow--my personal experiment was about a tenth the speed compared to backing up to an actual server computer over the same network.

Worse, Time Machine over the network is known for being a little on the flaky side, and routers serving data seem more prone to this. I was attempting to do just what you are with a WD MyBook and an Apple gigabit AEBS, which worked fine (albeit slowly) for about three or four backups before it would eventually corrupt the time machine image, causing total backup failure. It did this repeatably, and I've read a number of other people having exactly the same issue with similar hardware.

The same drive (and other similar ones) served from a Mini over the same network, however, is solid--never had an issue with it in the past ~1 year of use.

It's a pity that the technology doesn't seem to be quite there overall, but for the time being I'd recommend either doing your backups manually to the router/WD drive, or just using the drive with Time Machine connected directly to your Mac, where there will be no stability problems (and it'll be a lot faster).

The direct-connect method also has the advantage that the drive won't be plugged in most of the time, which will offer some protection from power spikes while it's not in use--say, a nearby lightning strike.