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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 quicklyempower the European Central Bank to supervise major lenders asa cornerstone of a strong banking union to underpin efforts totackle the region's debt turmoil, the Dutch central bank said.

Quick action was needed to cut the link between troubledbanks and indebted national governments, the central bank saidon Tuesday in a report on risks to the Dutch financial sectorthat highlighted differences between core euro zone states overhow to solve the crisis.

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

European Union leaders agreed at the end of June to set up asingle 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, meanthe deal is in danger of unravelling or at best beingsignificantly delayed.

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

The country's markets regulator Bafin said a deadline toestablish a euro zone bank regulator by January 1, 2013 wouldlikely be missed by a year.

The Dutch central bank also said the ESM, the permanent eurozone rescue fund that came into force on Monday, needed to begranted the option of directly recapitalising troubled banks ifshareholders or national governments could not.

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

Europe also needed a credible banking regulator in place.

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

Dutch finance officials have indicated that even though theyfavour the creation of a single supervisory body, it should onlybe allowed to directly recapitalise euro zone banks once it hasbeen shown to be "effective".

They have suggested that the International Monetary Fundcould be used to test the effectiveness of that authority andensure that it is ready to directly recapitalise, an auditprocess that could take time.

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

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

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

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

Keywords: EUROZONE BANKING/DUTCH