UPDATE 1-EU executive to propose gradual introduction of EU deposit scheme to win over Germany - draft

win over Germany - draft@ (Adds details)

BRUSSELS, Oct 5 (Reuters) - A European deposit insurance scheme should be introduced more gradually than initially planned, the European Commission is set to propose next week, in a bid to secure German support for a plan meant to increase financial stability in the euro zone.

In a draft document seen by Reuters, set to be published on Wednesday, the European Union executive arm will propose that the insurance scheme, known as EDIS, could initially provide only loans to support depositors of failing banks.

Only in a second phase the scheme would cover losses. This phase would start only when banks have sufficiently reduced their levels of bad loans, which remain still very high in some EU countries, like Italy, although they are decreasing.

Germany has long opposed the plan, fearing the money of its own banks could be called upon under the scheme to cover the payouts of deposits of banks failing elsewhere in the euro zone.

Germany has therefore said it could only agree to a pan-European deposit insurance scheme, which would guarantee the payout of all deposits up to 100,000 euros in all of the euro zone, only if risks of bank failure were reduced first.

This entails a significant reduction in the number of bad loans in the banking setcors of various countries and the Commission said it would present proposals next spring to make it easier for banks to recover debt.

The Commission will also propose a further development of a secondary market for bad loans, also known as non-performing loans (NPLs), so that banks can sell them.

The EU executive said it was also considering "minimum levels of provisioning which banks must make for NPLs", a measure that would reduce bad loans' risks but increase costs for banks.

In the 17-page draft document, the Commission also said it would propose that the European Central Bank extend its supervisory powers to large investment firms and funds. It already directly oversees 130 largest banks in the euro zone.

To reduce risks linked to bank failures, the European state bailout fund, the European Stability Mechanism, would be the best option as a backstop for the European Single Resolution Fund that finances bank resolutions, the Commission said.

To further increase financial stability and reduce risks from excessive bank exposure to the debt of their sovereigns, the Commission said it will consider proposing in 2018 a legal framework for the so-called sovereign bond-backed securities. (Reporting By Francesco Guarascio, editing by Jan Strupczewski)