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UPDATE 1-Europe tries to cut deal to close failing banks

Annika Breidthardt and Jan Strupczewski
Monday, 9 Dec 2013 | 1:18 PM ET

* Banking union marks new phase of euro zone integration

* France and Germany divided over breadth of the scheme

* Ministers face year-end deadline at EU leaders' meeting

BRUSSELS, Dec 9 (Reuters) - Europe is seeking to agree by year-end on how to close failing banks, part of an ambitious plan to create a single banking framework and fix broken lenders whose problems have festered since the financial crisis.

The main issues are: Who decides and who pays?

Under pressure to strike a deal before an EU leaders's summit next week, euro zone finance ministers tried to resolve differences on the first of two days of talks on Monday.

Despite ministers' optimism for a deal on Tuesday, when EU counterparts from outside the euro zone will join the talks, Germany remained opposed to any scheme that would allow the use of the bloc's rescue fund.

Creating an agency to close euro zone banks, as well as a fund to pay for the clean-up, would mark a deepening of integration of the 17 nations sharing the euro. But it raises complex questions of sovereignty and who will foot the bill.

Banking union, involving a single bank supervisor for the bloc and an 'executioner' to close banks, is the most ambitious project launched since the region's debt crisis and is designed to provide a stronger underpinning to the single currency.

"There's a chance (of a deal). It will be a lot of work," said Germany's Finance Minister Wolfgang Schaeuble.

But a German official rejected a euro zone proposal reported by Reuters that would allow the euro zone's bailout fund, the European Stability Fund, to lend and help finance the cost of any future bank clean-ups.

Ireland's Michael Noonan, arriving in Brussels, said there were still "wide differences" while Jeroen Dijsselbloem, who chairs the gatherings of euro zone ministers, said he was ready to call further meetings next week to reach a deal.

After more than three years of financial market turmoil following the bailouts of Greece, Ireland, Portugal and Cyprus, establishing a more unified banking system in the euro zone is seen as critical to defend against future crises.

But France and Germany have different visions of how a banking union would work in practice, with Berlin concerned about relinquishing power to a central bank agency.

Germany also does not want a single fund to pay for the clean-up. France, backed by Italy and Spain, however, want a new pan-euro zone show of unity.

In search of a compromise, ministers from the biggest euro zone economies - Germany, France, Italy and Spain - met in Berlin last week, although details of progress were unclear.

"Everyone is showing some flexibility because everyone wants a deal," Spain's Economy Minister Luis de Guindos said.

WHO WIELDS THE AXE?

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.

In essence, a banking union would make euro zone banks less dependent on governments in the countries they operate in, weakening the 'doom loop' between highly indebted sovereigns and the banks that finance them.

But for such a scheme to become reality from the start of 2015, ministers need to agree in the coming days on which EU institution should have the power to say that a bank anywhere in the euro zone must be closed.

Most euro zone countries are happy to let the European Commission, the EU executive, wield the axe and close banks, but Germany prefers the decision to be taken by the EU's 28 finance ministers, where Berlin holds much more sway.

Any compromise by involving both ministers and the Commission could be too time consuming given the need to act decisively so as not to spread market panic or a bank run.

Ministers must also decide how to pay for a bank restructuring or closure.

While the cost will eventually be borne by the banking sector itself from annual contributions, authorities may need extra cash up front before enough contributions accrues and the ministers have to agree who should make the advance.

To minimise any costs that euro zone taxpayers may have to cover, the ministers have already agreed that bank shareholders, bond holders and even depositors will be the first to lose money in the case that a bank is wound down.

But they have yet to agree on when the new, tougher rules on bank shareholder and creditor losses are to come into force. The initial plan was 2018, but this now looks likely to be pushed forward to 2016 instead.