By John O'Donnell
BRUSSELS (Reuters) - An impasse over plans for the European Central Bank to supervise banks, the European Union's most ambitious financial reform, takes centre stage at a finance ministers' meeting on Wednesday.
France and Germany, traditionally leaders in European integration, are at loggerheads over parts of the plan, and there is little time left for the European Union to meet a commitment to complete the framework for banking union by the end of the year.
Critical questions remain unanswered, such as how many banks the ECB should directly supervise and whether the central bank gets longer than one year, as planned, to fully take on its role.
After three years of piecemeal crisis-fighting measures, agreeing on a banking union would lay a cornerstone of wider economic union and mark the first concerted attempt to integrate the bloc's response to problem lenders.
But reaching a deal, which EU leaders want to sign off when they meet at a summit on Thursday and Friday, will require addressing the concerns of Germany, whose support is crucial, while also satisfying France and others with deep vested interests such as Britain, Sweden and the Netherlands.
"It's not an easy one for Germany," said one diplomat, close to the talks. "But the markets are watching us."
Another diplomat said it came down to a conflict between quality and speed: for the best banking union possible to be put in place it will take time and it may be necessary to extend agreed deadlines.
Berlin is concerned that supervision will develop into a scheme under which it is left to foot the bill for European banks too weak to survive when, as is planned, a central resolution scheme is set up to close troubled lenders.
It is also worried about a potential conflict of interest between the ECB's roles as supervisor and as guardian of monetary policy. Such a conflict could arise if the ECB were to decide to keep interest rates low to prop up banks.
In a sign of the tensions last week, German Finance Minister Wolfgang Schaeuble publicly clashed with France's finance minister at a meeting intended to finalize the plan.
Schaeuble objected to the ECB's Governing Council having the final say over monitoring banks, a stance that appeared to push the talks backwards. One official from a non-euro zone country said on Tuesday Schaeuble had softened his line since.
But France also has demands.
"We can envisage degrees of supervision depending on banks' size, but on one condition - that in the end the European Central Bank holds the ultimate responsibility," French Finance Minister Pierre Moscovici told Reuters earlier this week.
This concern is shared by analysts. "The ECB ultimately is the Governing Council," said Guntram Wolff of Bruegel, a think tank in Brussels. "Not leaving the final say with the Governing Council means you create a new institution. If you create a new institution, it would not have the credibility of the ECB."
PILLARS FOR UNION
Cyprus, which as holder of the rotating EU presidency chairs the meeting, will put a compromise proposal to the ministers.
An EU diplomat with knowledge of the discussions was upbeat about the prospect of bridging differences.
"We are very optimistic that we can reach a deal," the diplomat said.
In the compromise document, prepared in close consultation with Germany, France and Britain, Cyprus recommends that banks with assets of 30 billion euros or with assets larger than one fifth of their country's economic output be supervised directly by the ECB rather than national supervisors.
Banks with subsidiaries in two other states in the banking union would also be in that category. Critically, however, they leave the ECB with the authority to widen this remit to problem banks even if they are smaller.
The central bank's Governing Council would keep the final say in supervision, according to the proposal, which also lays emphasis on the need for a clear separation between monetary policy and supervision.
Ministers will also look at allowing the ECB to take longer than until January 1, 2014, to fully take on its role.
EU leaders hope that by setting up a single banking authority and later establishing a resolution fund for distressed banks, they will stop troubled banks from dragging their countries into crisis. They also hope to set up a way of coordinating national deposit guarantee schemes.
While most countries support the idea of supervision, which is the first pillar of a full banking union, they have disagreed on how to structure it and how far to go in sharing bank risks.
All 27 countries in the European Union must give approval for the project to go ahead, even if only those countries in the euro zone will fall under the banking union to begin with.
Sweden's Finance Minister Anders Borg, who had previously questioned the legal basis of the scheme, said that while his country was unlikely to join, it may allow other countries to press ahead if pan-EU voting safeguards are in place.
Britain has also demanded a voting scheme for countries outside the union to block certain decisions taken by the ECB, a veto that is opposed within the euro zone.
A report by the EU Committee of Britain's upper house of parliament stressed the need for London to obtain safeguards.
"I think the UK government has to wake up and go into battle for Britain and for the City of London," committee chairman Lyndon Harrison told Reuters.
Ratings agency Fitch said the ECB's pledge to buy the bonds of troubled countries if they seek euro zone aid had eased pressure for an immediate deal.
"(ECB President) Mario Draghi's announcement (on buying bonds) has taken the pressure off banking union negotiations for now," said Tony Stringer, a sovereign debt analyst at Fitch. "If they are able to demonstrate some progress as well as a clear path ahead, that may be enough for investors in the near term."
(Reporting By John O'Donnell; Additional reporting by Luke Baker, Niklas Pollard, Patrick Lannin and Johan Sennero Editing by Jeremy Gaunt and Alastair Macdonald)
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