EU to launch tricky supervision reform

BRUSSELS (Reuters) - EU finance ministers launch talks this week on how to reform market supervision but a clash with Britain appears inevitable on an issue where nations have traditionally been reluctant to cede sovereignty.

The talks in Prague will follow Thursday's G20 summit aimed at tackling the worst financial crisis since the Great Depression and the subsequent economic slowdown.

The crisis has highlighted inadequacies in the European Union's nationally organised system of financial supervision, such as who bails out a multinational giant in trouble.

Some 45 big banks like HSBC, BNP Paribas and Deutsche Bank account for 70 percent of total deposits. They must report to regulators in many European states, a costly process that leaves no clear overall picture of risk.

Former Bank of France governor Jacques de Larosiere has recommended setting up two new pan-EU bodies, one chaired by the European Central Bank to monitor system-wide risk, the other to ensure day-to-day supervision is consistent and adequate.

EU leaders have agreed the De Larosiere report must be the template for reform and that political decisions should be taken by year-end -- break-neck speed for a topic mired in disagreement for years. EU finance ministers and central bankers will start discussion in Prague on Friday and Saturday.

"These are the first steps that the ministers will be undertaking together with central bank governors," a euro zone government official said.

"The direction you take with the first step predetermines the direction in which the path will be going," he added.

That path may hit a few speed bumps soon, as vested national interests are barely below the surface despite talk from leaders that more streamlined supervision is needed.

BLOCKING MINORITY

EU states finally agreed last week on a new set of rules for the insurance sector but only on condition of ditching a core element of allowing a cross-border insurer's home regulator to have the final word on EU-wide capital requirements.

A blocking minority of 12 countries insisted on scrapping this element, fearing they would end up playing second fiddle to regulators in big states where many insurers are headquartered.

De Larosiere has proposed that the body overseeing day-to-day supervision can impose a course of action on a member state if its regulatory practice was inadequate.

Britain, the EU's biggest banking centre, has made a counterproposal for a purely advisory body that is non-binding on states so that it would not lose power over local banks.

Another tricky challenge is how the two bodies proposed by De Larosiere will work together so that monitoring system-wide risk -- so-called macro prudential oversight -- ties in with micro supervision of individual banks.

"Can we become better? The answer I think will be 'yes', but under what conditions can it become better? That's the interesting part," said the official.

A final deal will only be reached if there is consensus on how much power is transferred from national supervisors upwards to the two new pan-EU bodies.

Nout Wellink, head of the Dutch central bank and chairman of the Basel Committee of Banking Supervisors, said De Larosiere's proposals were only a first step as a key question is unanswered.

"If there is no agreement on who is to pay the bill at the end of the day in the context of cross-border resolution... a European supervisor as such is an approach that is not possible," Wellink said on Monday.

De Larosiere gives the ECB a central role, something which the Frankfurt-based bank has courted for months.

"I welcome its proposal on macro prudential supervision," the ECB's president, Jean-Claude Trichet said on Monday.

"The output of the systemic risk council will make a major contribution to financial stability in the EU," he added of the proposed new ECB entity.

But he added the council's risk warnings should be passed to EU finance ministers so they are heard "by the right quarters."

The EU's executive, the European Commission, will come forward with detailed legislative plans for turning De Larosiere's recommendations into practice. The plans are due to be given the green light by EU leaders at their summit in June.

(Editing by Victoria Main)