By John O'Donnell and Jan Strupczewski
BRUSSELS (Reuters) - EU finance ministers agreed on Tuesday they wanted tougher stress tests for the region's banks to restore confidence in the bloc's financial system, but remained locked in dispute over how strict they should be.
"We discussed bank stress tests ... and we are really agreed that the new stress tests should include more banks," said German Finance Minister Wolfgang Schaeuble.
"This is the clear position of the German government but also most of the others, and we should try to avoid that which happened last year," he added, commenting on July tests, branded irrelevant after they gave Irish banks a clean bill of health.
Michel Barnier, the European Commission official attempting to broker a deal with the EU's 27 countries on how the checks would work, highlighted continued disagreement on how this should be done. "We need to have more time to work on this," he said.
"We do need a few days on the issue of liquidity to see whether or not to go further on the question of sovereign risk," he added, flagging the most contentious point in the debate -- whether or not the taboo subject of a default on debt in Greece, for example, should be one of the test scenarios for banks.
Ministers also failed to reach a final decision on whether banks should be tested for a liquidity crunch to predict whether they could tough out borrowing difficulties should markets freeze.
A diplomat from Hungary, which currently holds the EU presidency, said ministers were near agreement on testing liquidity, even though no formal decision had been made.
The European Central Bank, which has spent billions supporting credit markets, and the European Commission want this check. But some countries fear it would present too bleak a future for banks and trigger calls for big capital injections.
LIQUIDITY CHECKS
There was uncertainty as to whether the liquidity checks would be published as investors want. The European Banking Authority, which will coordinate the new checks, said last week they would not.
"I am for liquidity being tested, but whether we should publish this must still be discussed," said Schaeuble.
"The question of what details we should publish is another question, and you have to keep in mind what kind of consequences this can have on the behavior of investors."
Late on Monday, the EU's economy chief Olli Rehn had promised the test results would be delivered by June.
"The results will come this summer," said the Hungarian diplomat on a timetable which could disappoint some investors who have been hoping for results as soon as next month to reduce uncertainty over the euro zone's banking system.
Last July, 91 EU banks were tested to assess how they would cope if lending such as home or commercial property loans turned sour.
But they did not consider the risk of a bank being forced out of business if it struggled to get credit itself or if savers withdrew deposits.
Both factors exacerbated the difficulties of Irish banks, whose mounting loan losses and funding difficulties eventually forced the Irish government to seek an 85 billion euro ($114 billion) EU/IMF bailout late last year.
With investor confidence in the euro zone shaken by indecision over how best to help countries that find it hard to borrow, officials in the European Commission hope a new round of stress tests can prove the bloc's financial system is sound.
But they face obstacles. Germany's regional lenders, or landesbanken, were among the worst hit by the financial crisis, and were reluctant to take part in the last tests.
Even Deutsche Bank hesitated before revealing its exposure to government debt.
Despite the influence of the Commission -- many of the staff in the new banking watchdog in charge of testing will come from its ranks and it has a say in setting criteria -- Barnier needs the support of others to tighten the controls.
The EU's July tests were meant to reassure investors by uncovering hidden problems and forcing weaker lenders to recapitalize. Only seven of 91 failed. Not one was from Ireland, prompting critics to label the exercise irrelevant.
Observers remained skeptical about whether the tests would reflect the true financial health of Europe's lenders.
"The tests will be tailored to achieve the results regulators want to see," said a senior investment banker specialized in banking transactions, who declined to be named.
Test results that show European lenders to be in very bad health could cause a freeze in the interbank lending market, exacerbating the financial crisis regulators are struggling to contain, he added.
(Additional reporting by Sarah Marsh, Julien Toyer and Edward Taylor in Frankfurt; Editing by Susan Fenton)
