European Union Weighs Banking Union In Aim To Help Spain

EU Weighs Banking Union, As Spain's Banking System Crumbles

* IMF's Lagarde calls on euro zone to stand by banks

* De Guindos says direct recapitalisation may be open to Spain

* Finance ministers in Luxembourg to discuss banking union

* Germany ditches bid to win pan-EU support for transactions tax

By John O'Donnell and Robin Emmott

LUXEMBOURG, June 22 (Reuters) - European finance ministers examined ways on Friday to bolster weak banks and break the link between troubled lenders and indebted countries, with concerns about Spain's stricken banking system at the top of their minds.

IMF Managing Director Christine Lagarde has urged the euro zone to channel aid directly to struggling banks rather than via governments, but Germany and others are opposed to such support, which is not possible under current euro zone rules.

The discussion is part of a broader debate about how the European Union or at least those countries in the euro zone can move towards a 'banking union', including a joint deposit guarantee scheme and a fund to wind down failing banks, and get on top of the 2-1/2-year sovereign debt crisis.

Those issues will be discussed in detail by EU leaders at a summit in Brussels on June 28-29.

Lagarde said on Thursday that by allowing the euro zone's rescue fund, the European Stability Mechanism, to aid stricken lenders directly rather than via a programme of government aid, it would break the bank-to-sovereign debt link.

"The process of forming a banking union has begun," said Luis de Guindos, Spain's economy minister, adding that the possibility of direct recapitalisation may be open to Spain, which is set to receive up to 100 billion euros ($126 billion) of aid from the euro zone for troubled banks.

"I think (direct bank recapitalisation) is a possibility," he told reporters. "It is one of the fundamental elements to break the link between bank risk and sovereign risk."

"This possibility is absolutely open to Spain if there is progress in the next few months (on the issue). The process of recapitalisation is not instantaneous," he said.

Throughout the crisis, countries in the euro zone have been left to resolve problems at their banks themselves. For those for whom the burden was too great, such as Ireland, the government received aid from the IMF and EU to do it.

But after years in crisis, the banking sector problems show no sign of abating and Europe's leaders are under pressure to form a united front to shield struggling lenders rather than leave countries to cope with the problems alone.

At their summit, EU leaders will look at how to establish a banking union, including a single supervisor for the largest banks, a fund to wind down cross-border lenders in trouble and more-assured guarantees to protect depositors.

"POISONOUS LINK"

Central to this is the idea is that stronger countries in the euro zone such as Germany ultimately stand behind the lenders of countries too weak to manage alone, although Berlin does not want any such step in the short term because it is opposed to bearing any liability for other countries.

"We need to break the poisonous link between sovereigns and banks," said one EU diplomat close to discussions. "It's about solidarity. It can't happen overnight. It is difficult stuff."

A banking union is also contentious because it will likely shift power from national regulators to a higher authority, such as the European Central Bank. France and Germany want the ECB to take charge of major banks, rather than leaving oversight with the EU's fledgling European Banking Authority.

One of the biggest divisions in the debate about such a union is whether it will apply only to countries in the euro zone, or to all 27 member states in the European Union.

Britain has said it will not join such a scheme, which it believes should be limited to the single currency area.

The European Commission, the EU's executive, wants the union to apply to all countries, because of concerns that scaling it back would undermine the bloc's borderless single market.

Michel Barnier, the EU commissioner in charge of financial regulation, will attend the meeting to appeal again for all countries to join.

Germany ditched efforts on Friday to win agreement across the European Union on a tax on financial transactions at the meeting on Friday and will instead push for a core group of countries to introduce a levy.

By embarking on this path, the German government hopes to placate demands by the main opposition in parliament to move towards such a tax in return for their support in approving the euro zone's rescue fund, the European Stability Mechanism.

Speaking to fellow EU finance ministers, Germany's Wolfgang Schaeuble said that he accepted that there would be no agreement across all 27 members of the European Union and would now seek to build a scaled down group.

"My impression is that quite a number of member states strongly support the proposal of an FTT (Financial Transactions Tax) in principle," he said, during a part of the meeting that was publicly broadcast. "We should give it a try."

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