BRUSSELS (Reuters) - European Union countries will consider bending to German and British demands to soften the power of the ECB in supervising banks to get agreement on banking union, according to a document obtained by Reuters.
After three years of piecemeal crisis-fighting, European countries are attempting to agree on a banking union to lay a cornerstone of wider economic integration and protect the euro.
It is designed to unify the bloc's response to problem lenders but the reform is deeply divisive and has prompted fears across Europe, from Berlin to London, that the new construct will give the ECB too much power at the expense of national regulators.
Now diplomats from Cyprus -- which holds the rotating EU presidency and is seeking to broker a compromise -- have suggested changes to break a logjam in talks and make the plan more acceptable, in particular, to sceptical countries outside the euro such as Sweden and Poland.
The proposal, dated November 16, recommends a structure that will make it possible for countries outside the euro who join the scheme to exempt themselves from decisions taken by the European Central Bank, although that could result in their expulsion from the banking union.
"The non-euro participating Member State may notify the ECB that it will not be bound by that decision," officials write. "The ECB shall then consider the possible suspension or termination of the close cooperation."
"They are moving towards a way to accommodate non-eurozone countries and also trying to give the national supervisory authorities more power compared to the ECB," said one official, familiar with the compromise, which will be discussed by officials negotiating a banking union on Tuesday.
Diplomats will also consider a suggestion, backed by the Netherlands and Luxembourg, to modify one of the most significant powers the ECB would receive under the new regime.
Under this proposal, the ECB would also not be allowed use its power to call for the closure of a stricken bank, until a resolution system to wind down and pay for troubled lenders is in place -- a distant prospect.
The document also suggests giving the ECB's bank supervisory body, where countries are represented, stronger executive powers as well as more autonomy to countries to decide when banks should set aside more capital to cover losses.
Under the latest proposal for compromise, the ECB would, however, retain the final say in supervising all banks in the euro zone as well as other countries that choose to join.
"The latest versions reflects very much the complaints of the member states, not by reducing the rights and powers of the ECB, but making more explicit the rights and powers of the member states," said a second official.
The diplomatic push comes amid growing concern in Brussels that the construct is already crumbling in the face of powerful opposition both within and outside the euro.
Germany, the leading economy in the euro zone, is pushing to restrict the ECB's oversight to top banks while Britain, the biggest country outside the euro, wants to stop the central bank from taking decisions that infringe on its interests.
Making the ECB the supervisor for lenders chiefly in the 17 countries that use the euro would be the first of three pillars in a banking union and one EU leaders have committed to complete by the year-end.
When supervision is in place, it would pave the way for the euro zone's rescue fund, the European Stability Mechanism, to help troubled lenders directly rather than via governments.
Longer-term plans for a central scheme to wind down banks and a combined means of deposit protection to prevent bank runs would complete the banking union, underpinning lenders.
Britain has proposed a means for countries outside the banking union to stop the ECB taking decisions that could affect their interests.
Germany, which wants to keep primary oversight of the country's community savings banks, wants to limit the ECB's remit to systemically important lenders.
It is also worried that the more banks are included in the scheme, the higher the potential cost when, as is ultimately planned, supervision is backed up by a central fund to pay for the closure of troubled lenders.
(Reporting By John O'Donnell. Editing by Jeremy Gaunt.)