UPDATE 1-Europe moves closer to scheme to close troubled banks
* EU ministers to decide who can close down banks, who pays
* Germany opposes use of bailout fund to back-up bad banks
* Berlin seeks to fast-track losses for bank creditors
BRUSSELS, Dec 10 (Reuters) - European Union countries edged slowly towards agreeing a scheme to shut failing banks on Tuesday, although a final deal on wider reform to prevent a repeat financial crisis may not be reached until next week.
After 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 unanswered.
On Tuesday, European Union finance ministers began negotiating how to create an agency to close euro zone banks and a fund to pay for the clean-up - completing a 'banking union' where the European Central Bank polices the sector.
"I believe that a political agreement is possible today, even if there is further legal work to be done afterwards," French Finance Minister Pierre Moscovici told reporters.
"I would like to leave tonight with an agreement already clearly drawn."
A banking union is widely viewed as essential to shore up the currency-sharing group against future debt and financial crises.
But building such a union is as divisive as it is ambitious. It requires countries such as Germany to surrender sovereignty and could demand that they pay towards repairing banks in neighbouring states.
Financial markets have paid little attention to the debate but there is a risk that failure to reach an agreement could be taken as a sign the bloc is not capable of protecting itself.
European leaders want a deal by the end of the year so that banking union can begin by 2015. But they will have to overcome numerous contested issues.
For one, Germany wants to fast-track rules pencilled in for 2018 that will impose losses on a failing bank's bondholders or even its big savers, as was done in Cyprus, in return for its support for the wider banking union scheme.
Its drive to have these rules from 2015 has significant implications for bondholders as well as savers with more than 100,000 euros ($137,200) in their account.
"The council (of ministers) has sent a strong signal to markets that we want to protect taxpayers and that the time for bailout is over," Germany's finance minister, Wolfgang Schaeuble, told ministers on Tuesday.
Many European Union finance ministers, however, nervous that the rules' early introduction could rattle markets, spoke out against fast-tracking the law.
Italian Finance Minister Fabrizio Saccomani made it clear that he would only support Germany in return for concessions on a common euro zone back-up plan for failing banks.
"We are available to discuss it ... if there is a single resolution fund and common backstops are clearly agreed upon and in place," he told his peers in remarks broadcast to reporters.
Ultimately, a compromise is likely and officials have predicted a start-date of 2016.
BRIDGING THE DIVIDE
A deal among governments on how to wind down banks by the self-imposed year-end deadline is important because it will allow countries to deal with potential problems revealed by a health check of banks by the ECB next year.
Failure to reach agreement would reflect badly on the bloc's politicians, whose response to the crisis has at times been slow and chaotic.
"I would expect that ...we will manage to narrow down the differences today," said Joerg Asmussen, a member of the European Central Bank's Executive Board.
"I do not expect that we will reach a final agreement already today," he said, adding that he had "pencilled in" another meeting of EU ministers before the bloc's leaders meet on December 19-20.
The most contentious problems are: Who decides and who pays?
For the bank union to work, an agency has to get the power to close down a bank. Most countries would like this job to go to the EU's executive arm, the European Commission.
But Germany, Finland and Slovakia would prefer such decisions to be made by all EU ministers, especially where the closure of the bank would require them to pitch in help.
How to pay for a bank closure is even more complex.
While all such expenses are eventually meant to be covered by the banks themselves, the question is where to get the money until their contributions gather critical mass.
"It is key from our side that especially in the transition period, when the fund does not have enough money, it has a credible backstop," Asmussen said.
Most ministers agree that this fund should get help, as a last resort, from the euro zone's bailout fund, without involving governments. But Germany opposes that.