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PREVIEW-Europe struggles to agree plan to close sick banks

John O'Donnell and Jan Strupczewski
Friday, 6 Dec 2013 | 5:54 AM ET

* Finance chiefs to seek deal on who should shut bank

* Countries also to decide how to pay for winding-down

* Deep divisions over scheme remain

BRUSSELS, Dec 6 (Reuters) - European ministers make a fresh attempt next week to agree a blueprint to close failing banks but progress is uncertain as the fundamental questions of who gets the power to close a bank and how to pay the bill remain open.

As the dust settles from a financial storm that toppled banks and dragged down states from Ireland to Spain, the question of what to do when a bank fails remains controversial.

On Tuesday, European finance ministers will negotiate how to create an agency to close euro zone banks and a fund to pay for the clean-up - completing a new system to police banks and prevent a repeat crisis.

This part of a 'banking union' is as divisive as it is ambitious. It requires countries such as Germany to surrender sovereignty to this European agency and could demand they pay towards repairing banks in neighbouring states.

European leaders want a deal by the end of the year so that the banking union can become reality from the start of 2015, raising investor confidence and helping bank lending.

Some officials are optimistic that this could happen on Tuesday. "Having listened to a number of key players, I am confident that an agreement can be struck," one senior euro zone official involved in the talks said.

But others speculate that another gathering of finance ministers on Dec. 18 might be necessary.

German and French finance ministers were expected to meet later on Friday to advance talks on the issue.

After weeks of wrangling ahead of the meeting, differences between euro zone countries remain.

Germany, which neither wants to surrender control of its regional savings banks to European bureaucrats nor end up footing the bill for failures elsewhere, is treading carefully not least because a coalition deal to form the next government has yet to win final approval from the Social Democrats.

Berlin would rather see European countries decide the fate of failing banks and exclude its regional banks from the scheme. It does not want the European Commission to do the job.

With so much at stake, it may fall to Europe's political leaders, including German Chancellor Angela Merkel and France's Francois Hollande, to negotiate an agreement when they meet in Brussels on Dec. 19-20.

OBSTACLE COURSE

The European Central Bank, which is due to take on the supervision of big banks in the euro zone towards the end of next year, is watching apprehensively.

ECB President Mario Draghi underscored the importance of banking union this week, the most far-reaching reform since the euro was established, when he told journalists that it was necessary to "restore confidence".

But the path to completing it is strewn with obstacles, and time is running out for the ministers to strike agreement. One of the most sensitive questions is how to deal with banks so badly wounded that they need to be closed.

The ECB wants a new 'resolution' agency that is independent of political interference to prevent a repeat of the chaos that surrounded the collapse of banks such as Franco-Belgian group Dexia that were active in many countries.

But negotiations in Brussels are moving in the opposite direction. Draft proposals seen by Reuters show diplomats are setting up an unwieldy system that would involve every EU country, the Commission and the ECB in any bank emergency.

Their notes, decisions and proposals could go back and forth for days, it said.

"The U.S. agency has 48 hours to resolve a failed institution," said one official, familiar with the talks. "The complicated European decision-making structure barely enables such a quick decision."

EMPTY WAR CHEST

There are other open questions, such as who should pay for winding down banks.

While bank closures should ultimately be paid for by a banks-funded war chest, that will be empty for many years.

In the meantime, countries will have to decide who pays. Germany, however, is reluctant to allow Spain or others tap European money for this purpose.

It also does not want to use the euro zone's rescue fund, the European Stability Mechanism, to lend money for tackling failing banks.

Berlin may concede on this point but only if other countries agree to fast-track rules that would allow the imposition of losses on bondholders and large depositors of failed banks, similar to the harsh methods used when bailing out Cyprus.

Those rules are now pencilled in for 2018. Berlin, keen to prevent a repeat of the trillions of euros of state bank bailouts, wants the law from 2015. Many officials say 2016 is the more likely compromise date.

(Additional Reporting By Martin Santa; Editing by Susan Fenton)