Pre-summit document presses EU banking union

BRUSSELS (Reuters) - European leaders will discuss specific steps towards a cross-border banking union, closer fiscal integration and the possibility of a debt redemption fund at a summit on June 28-29, according to a document prepared for the meeting.

Two officials familiar with the 10-15 page document, drawn up over the past month and which is still being revised ahead of the summit, said it sets out in detail the four "pillars" required for a strong economic and monetary union which leaders believe is necessary to secure the currency project's future.

As well as progress towards a banking union, the paper discusses the need for a more integrated budget policy, steps required for deeper economic integration, and how to retain "democratic legitimacy" if countries give up some sovereignty.

The document has been drafted by European Commission President Jose Manuel Barroso, European Council President Herman Van Rompuy, European Central Bank chief Mario Draghi, and Jean-Claude Juncker, head of the Eurogroup countries using the euro.

European leaders have already said the first area they need to work on is a banking integration as they try to break the link between bad banks and indebted governments, with the worsening situation in Spain an immediate concern.

EU officials believe that could be achieved in a year, although Berlin wants to see much more progress towards fiscal integration first, something that would require much longer due to the need to change the European Union treaty to achieve it.

The document goes into most detail on the banking proposals, setting out the need for a single European banking supervisor, a common EU deposit-guarantee scheme and a single bank-resolution fund to wind down the region's bad banks, the officials said.

The paper sets out options under each heading, saying that when it comes to a single banking supervisor it could either be charged with overseeing all EU banks, or else look after the major systemic banks with cross-border operations, while another body looks after broader, day-to-day oversight.

The expectation is the ECB will eventually be given sole responsibility for overseeing Europe's biggest banks, while the European Banking Authority watchdog retains a broader oversight role along with coordinating the work of national regulators.

On a common deposit insurance mechanism, the paper suggests that there needs to be a strengthening of and closer integration among national guarantee schemes to provide a more reassuring backstop across the whole European Union.

On a resolution fund to deal with failing banks, it calls for a single mechanism "with a large envelope" that would be financed via levies on the banking sector, such as a financial transaction tax, and would offer "an integrated EU solution for resolution".

The document, which draws heavily on proposals made by the European Commission on June 6, says an "immediate and permanent mutualisation" of risk may be required to backstop the banking sector. It suggests the euro zone's permanent ESM bailout fund could be used to recapitalize banks directly, rather than having to lend to governments for on-lending to banks.

All of those proposals would be possible under existing EU treaties and could be implemented relatively rapidly, the document indicates.

Even if it took only a year, this will probably not come quick enough to ease market pressure on Spain and Italy that is now reaching danger levels, although some analysts believe a strong signal of intent could help. That could also persuade the ECB to step in.

"Short term, there is clearly a risk that the summit will disappoint markets yet again. If that were to be the case, I have no doubt that the ECB will step in," said Erik Neilsen, global chief economist at Unicredit.

That could take the form of an interest rate cut, further easing of collateral rules for Spanish banks so they can continue to access ECB funds or even a resumption of the bank's bond-buying program, which several of its policymakers oppose, he said.

BUDGET INTEGRATION

In a second section examining the steps required for closer fiscal coordination, the document says there is a need to go beyond existing legislative proposals such as the fiscal treaty, which 25 of the EU's 27 countries have signed up to and which commits them to a balanced budget.

The paper says that as closer banking and fiscal integration is achieved, the issue of mutualisation of debt will become more immediate and it raises the option of a debt redemption fund along the lines of that proposed by Germany's "wise men".

That is an idea that France, Italy and others have pushed hard for but which German Chancellor Angela Merkel opposes.

Merkel has not ruled out a sharing of debt per se, but has said any discussion on it can only happen at the end of a long process of integration that is likely to take many years. In contrast, France will find it difficult to stomach the loss of sovereignty that fiscal union would demand.

"The political leaders are now trying to move to a degree of fiscal and political union within a very short period of time. In democracies, such changes usually take a few years, and whether enough can be achieved in time remains to be seen," Neilsen said.

"However, in my mind, this does not imply an imminent risk of a breakdown of the euro zone ... It's a political project, and political leaders are unlikely to throw in the towel because markets don't like the policies."

Other sections of the document discuss the broader aims of greater EU labor mobility, efforts to improve pan-EU competitiveness, and to examine common taxation such as a common corporate tax base and a financial transactions levy.

There is likely to be heated discussion on issues such as debt mutualisation and any pooling of liability under a banking union, with Germany adamant that it will not be put on the line to underwrite the liabilities of other euro zone countries.

No decisions are expected at the summit, but if leaders agree that there are grounds to push ahead, Barroso, Van Rompuy and the others will be given a further mandate to develop the ideas in greater detail, including more specific timelines.

Van Rompuy has said he hopes to have a more thorough set of plans drawn up by the next EU leaders' summit in October or possibly the one after in December.

(Writing by Luke Baker; Editing by Ralph Gowling)

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