Time runs short as Europe haggles over key bank reform

BRUSSELS (Reuters) - European countries haggled on Tuesday over a scheme to insulate taxpayers from the costs of bank failures, redoubling efforts to avoid an embarrassing delay to the euro zone's centrepiece crisis reform.

The protracted talks show the politically charged nature of the plan to disentangle states and the banks from which they borrow. A future agency to wind down failing banks, and a fund to pay for the clean-up, will complement European Central Bank supervision of euro zone banks.

A final deal between countries and the European Parliament had been pencilled in for this week but ministers entering the second day of talks on Tuesday conceded that it may take longer because of deep differences.

Divisions were laid bare as Spain and the Netherlands sought to win over a reluctant Germany to support the 'resolution' fund from its outset, when it will be small.

Such support could take the form of credit or guarantees to show investors the fund has enough cash to deal with failing lenders right from the beginning.

"This is important for the signal it sends to markets," Spain's Economy Minister Luis de Guindos told journalists of the wider banking union, adding that negotiations could be finished next week.

Inside the meeting, he joined Dutch finance minister Jeroen Dijsselbloem in flagging the need for countries to club together in tackling problem banks.

"For the very first years of the fund we need firepower to face up to difficult situations at our banks," de Guindos said, while Dijsselbloem suggested a credit line from governments.

But German Finance Minister Wolfgang Schaeuble showed little willingness to compromise. "We have agreed in December not to touch the issue of a common backstop," he said. "We will not find a solution now."

Although signed off by states in December, the fine print governing how the new 'banking union' regime will work has reignited debate.

Time is running out because the parliament has its last sitting in mid-April before disbanding for May elections. Failure to seal a deal before then would mean months of delay and uncertainty given an expected rise in the number of eurosceptic lawmakers after the poll.

Banking union is the most ambitious political project in Europe since the euro. Yet it means different things for the countries involved.

COMMON GOAL?

While France and Spain see it as a step towards sharing bank risks with Germany and advancing towards a common cost of borrowing across the euro zone, Berlin places greater emphasis on imposing losses on the creditors of laggard banks.

"We need to break the vicious circle between banking debt and sovereign debt," French Finance Minister Pierre Moscovici told reporters earlier. "It's also a question of unifying the interest rates in the European Union."

Germany's Schaeuble, on the other hand, emphasised the need for strict 'bail-in' rules to impose losses on bondholders and other creditors of failing banks, as happened when Cyprus was bailed out last year.

"It's clear that the bail-in rules apply," said Schaeuble. "They can't be weakened because it makes no sense to constantly talk about the taxpayer no longer having to foot the bill and then to begin not applying the rules about owners and creditors taking the risk at the start."

These rules are due to come into force in 2016 but Germany wants them to apply within the euro zone from when the ECB takes on its role of banking watchdog, at the end of this year.

That would herald tougher treatment of investors in banks found to be in poor health in ECB health checks.

The banking union, and the clean-up of lenders' books that will accompany it, is intended to restore banks' confidence in one another and boost lending across the currency bloc, helping foster growth in the 18 economies that use the euro.

New lending has been throttled by banks' efforts to raise capital and cut their risks during a recession, especially in countries hit hardest by the sovereign debt crisis.

The banking union is supposed to break the link between indebted states and the banks that buy their debt, treated in law as 'risk-free' despite Greece's default in all but name.

CUMBERSOME

Euro zone banks now hold about 1.75 trillion euros of government debt, equivalent to 5.7 percent of their assets and the highest relative exposure since 2006, according to the European Central Bank. In Italy and Spain, roughly one in every 10 euros in the banking system is now on loan to governments.

At the heart of the dispute over the scheme is the complex process of closing a bank. Countries are reluctant to cede authority to Brussels and want a laborious system of checks before any decision to shut a bank can be taken.

But the parliament does not want EU ministers involved, arguing it politicizes the process and makes it cumbersome.

Governments and parliamentarians also disagree on how quickly to build up the fund, which will be filled to the tune of 55 billion euros ($76 billion) by euro zone banks, and how soon countries should be able to dip into the pot.

This issue was overtaken on Tuesday by the question as to how the small fund should be supported at its outset.

(Writing by John O'Donnell; Additional reporting by Barbara Lewis, Robin Emmott and Jan Strupczewski in Brussels and Matthias Sobolewski in Berlin; Editing by Catherine Evans)