By John O'Donnell and Robin Emmott
BRUSSELS (Reuters) - Germany and France publicly clashed on Tuesday over plans to put the European Central Bank in charge of supervising banks, deepening a dispute over the scope of the ECB's powers that threatens to undermine one of Europe's boldest reforms.
With time running out to meet a pledge to complete the legal framework for an EU-wide banking union by the end of the year, Germany's Finance Minister Wolfgang Schaeuble told a meeting of EU finance ministers he said could not support a plan that would give the ECB the final say on supervision.
France's Pierre Moscovici protested against any watering down of a plan central to Europe's response to a five-year banking crisis that promises to unify the way it deals with problem banks and end a previously haphazard approach.
"The right of the last decision cannot be left to the ECB Governing Council," Schaeuble told a meeting of finance ministers in Brussels in comments broadcast to reporters, adding that there could be no deal unless national supervisors had responsibility for most banks.
"A Chinese wall between banking supervision and monetary policy is an absolute necessity," he said, also voicing skepticism that an independent central bank such as the ECB should even take on the tasks of supervision.
Moscovici countered that EU leaders who had given finance ministers responsibility for drawing up a supervisory framework had always placed the ECB at the center of their vision.
"We have no mandate for a dual system of supervision which would call into question the existence of a single system for some banks," Moscovici told the meeting.
The depth of divisions between France and Germany, the two biggest economies at the heart of euro zone integration, pointed to the difficulty of reaching an agreement on Tuesday.
Three EU officials close to the talks told Reuters that ministers were likely to gather again on December 12. The euro slipped against the dollar on the news.
Most countries support the idea of banking supervision in principle but many disagree on how best to structure it or how far to go in unifying banking systems to share risk and prevent discrimination between euro and non-euro countries.
Spain's Economy Minister Luis De Guindos said the future of the euro depended on a deal. "Banking union is key to dispel the uncertainties over the future of the euro zone," he said, voicing misgivings about a scheme that does not cover all banks.
Complicating the debate further is Sweden, a non-euro zone country that has substantial banking interests in Finland, which uses the euro. Sweden is concerned that if the ECB is to have oversight of assets it owns, it must have some level of equal representation at the ECB.
Sweden's Finance Minister Anders Borg appeared to soften his stance on Tuesday, having threatened to block an agreement.
"There can be no unfair treatment of the non-euro countries. There must be safeguards and we must be able to set our own... higher capital requirements for banks," Borg told reporters.
Diplomats also need to address the concerns of non-euro zone countries that aim to join the currency, such as Poland and Hungary, which also want to ensure they are not disadvantaged by the ECB taking a more powerful oversight of their banks.
EU leaders hope that by setting up a single, powerful banking authority and later establishing a resolution fund for distressed banks, they will cut the link between indebted countries and their banking systems and start to right some of the wrongs that have exacerbated the debt crisis.
But Germany is concerned the project will develop into a scheme under which Berlin is left to foot the bill for banks too weak to survive on their own. And it is wary about directly recapitalizing banks from the euro zone's rescue fund, which will be possible once banking union is up and running.
EU leaders agreed at a summit in October that they would have the framework for banking union agreed by year-end and the ECB would start to take responsibility during 2013.
If ministers reach agreement next week, it might allow them to finalize the framework by a summit of EU leaders on December 13-14, as long as the European Parliament also plays its part and gives its approval. Hitting the deadline would send a strong signal, but it remains a long shot.
One of the trickiest obstacles is how to ensure that any supervisory system involving the ECB - an institution set up to manage euro zone issues alone - does not discriminate against non-euro zone countries such as Sweden and Denmark.
Hungary is another challenging case - about half of its lenders are owned by euro zone banks, meaning Budapest has a strong incentive to prevent the ECB taking decisions that could hurt its national financial system or sideline local lenders.
Another important reform, the introduction of stricter rules on banks' capital reserves in Europe, known as Basel III, is unlikely, however, to be finalized by ministers, delaying the new regime beyond a planned start on January 1 next year.
(Additional reporting by Annika Breidthardt; Editing by Rex Merrifield and Luke Baker)
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