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Euro zone set for drawn-out battle over banking rules

(L-R) European Union Economic and Monetary Affairs Commissioner Olli Rehn, Greece's Finance Minister Yannis Stournaras, France's Finance Min
(L-R) European Union Economic and Monetary Affairs Commissioner Olli Rehn, Greece's Finance Minister Yannis Stournaras, France's Finance Min

By Jan Strupczewski

BRUSSELS (Reuters) - Euro zone finance ministers face difficult talks over their plans for a banking union on Tuesday, including how to pay for the winding up of troubled banks, a deeply divisive issue on which Germany has dug in its heels.

The aim is for ministers to reach agreement in the next 36 hours, so that European Union leaders can sign off on it at a summit on Thursday and Friday. But already officials are warning that an extra finance ministers' meeting may be necessary at the end of December if a deal cannot be reached this week.

Discussions over a banking union - the most ambitious project the EU has undertaken since the introduction of the euro - have already dragged on for the best part of a year and show few signs of getting any easier or less complicated.

Ministers have already agreed on the first plank of the plan, which involves making the European Central Bank the single supervisory authority for the region's largest banks. The ECB is on target to take over that role from the end of 2014.

But the second plank, which involves creating a single authority for winding up or resolving problems in the region's banks, alongside a single fund for financing resolution, is proving even more cumbersome and challenging than the first.

Germany, the euro zone's largest economy, has raised the greatest concerns about the resolution fund, which it fears is a major step towards mutualising risk across the euro zone.

With divisions running deep, ministers may decide to sidestep the thorniest issues for now so as to reach a general political agreement and stick to an ambitious timetable for the banking union project to start in 2015.

"You don't need to have full agreement on every detail to have political agreement on a Single Resolution Mechanism," one European Union official said.

A general agreement among the ministers is all that is needed to start negotiations with the European Parliament on the legislation, with the first discussions with parliament already penciled in for January 7.

On Wednesday, ministers will discuss who will have the power to close down any of the 6,000 banks in the euro zone and under what procedure. On Tuesday, the talks are likely to focus on the money and who pays, EU officials said.

Banks themselves will provide the cash needed to finance the winding down of failed lenders through annual contributions to a Single Resolution Fund that, in total, are to reach 55 billion euros over 10 years.

But ministers cannot yet agree how to ensure there is enough money to deal with closures during the 10-year transition period and what happens if, in some extreme case, more money is needed than has accumulated in the single fund.

Under the latest proposal, the cost of closing down a euro zone bank will initially be borne almost fully by its home country. The obligations of euro zone partners will only gradually rise to be shared equitably after a decade.

The problem is what to do if a bank closure during that transition period costs more than the system can provide.

Germany wants the government of the country where the failing bank is based to provide the missing cash, or borrow it from the euro zone's bailout fund, the 500-billion-euro European Stability Mechanism, as Spain did in 2012.

But France points out that would conserve the vicious circle of weak sovereigns trying to support weak banks, the very link the euro zone has said it wants to break via a banking union.

Many policymakers believe the solution is to allow the bailout fund to backstop the Single Resolution Fund directly, not via governments, during the 10-year build-up phase and then to continue acting as a 'backstop' once the fund is full.

Since the resolution fund would have the right to get contributions from banks, its ability to repay any loan from the bailout fund is not in doubt, they argue.

Germany firmly opposes that idea, arguing that if governments are ultimately liable, they will be more focused on managing their banking sectors well and preventing lending bubbles that could trigger another crisis.

Berlin also questions the certainty of the ESM loan always being paid back by the Single Resolution Fund.

(Additional reporting by John O'Donnell and Martin Santa; Editing by Luke Baker)

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