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UPDATE 1-Dutch c.bank urges quick European bank supervision

* Says ECB should be empowered fast to supervise major banks

* Says ESM rescue fund should be able to recapitalise banks

(Adds detail)

AMSTERDAM, Oct 9 (Reuters) - Policymakers should quickly empower the European Central Bank to supervise major lenders as a cornerstone of a strong banking union to underpin efforts to tackle the region's debt turmoil, the Dutch central bank said.

Quick action was needed to cut the link between troubled banks and indebted national governments, the central bank said on Tuesday in a report on risks to the Dutch financial sector that highlighted differences between core euro zone states over how to solve the crisis.

"An effective banking union offers a way out from the negative interaction between banks and governments and halt capital flight," said the central bank.

European Union leaders agreed at the end of June to set up a single supervisory authority to oversee 6,000 banks in Europe, with the aim of having it in place by the end of the year.

But misgivings raised since then, notably in Berlin, mean the deal is in danger of unravelling or at best being significantly delayed.

Early last month, Germany said it was unrealistic for the ECB to oversee more than the bloc's biggest institutions.

The country's markets regulator Bafin said a deadline to establish a euro zone bank regulator by January 1, 2013 would likely be missed by a year.

The Dutch central bank also said the ESM, the permanent euro zone rescue fund that came into force on Monday, needed to be granted the option of directly recapitalising troubled banks if shareholders or national governments could not.

A model was being created to make the ECB supervisor over banks that received aid or requested it, but after getting these powers, the ECB should quickly regulate banks seen as vital to the banking system, including local banks.

Europe also needed a credible banking regulator in place.

A third step in creating a European banking union was to establish a pre-funded, common deposit guarantee and resolution fund, the Dutch central bank said.

Dutch finance officials have indicated that even though they favour the creation of a single supervisory body, it should only be allowed to directly recapitalise euro zone banks once it has been shown to be "effective".

They have suggested that the International Monetary Fund could be used to test the effectiveness of that authority and ensure that it is ready to directly recapitalise, an audit process that could take time.

Dutch banks were not expected to have much room to pay dividends in the next few years due to increased capital demands, higher bad loans provisions, and higher funding costs, the central bank also said.

(Reporting by Gilbert Kreijger; additional reporting by Luke Baker in Luxembourg; Editing by John Stonestreet)

((gilbert.kreijger@thomsonreuters.com)(+31205045007)(Reuters

Messaging: gilbert.kreijger.reuters.com@reuters.net))

Keywords: EUROZONE BANKING/DUTCH