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LONDON (Reuters) - A banking union will help the euro zone resolve its debt crisis but Britain must obtain safeguards to avoid its banks being damaged by a too-powerful European Central Bank, a parliamentary report said.
Like the government, the report by the European Union Committee of the Lords, backs a euro zone banking union in principle to help stabilise the sector, but it stressed the need to get key details right.
Finance ministers from all 27 EU states will try to thrash out a deal on the banking union on Wednesday for EU leaders to endorse at a summit on Thursday and Friday.
Lyndon Harrison, chairman of the Lords committee, accused the government of "sleepwalking" into negotiations which, if badly handled, would create a banking union that marginalised Britain's financial services industry.
"I think the UK government has to wake up and go into battle for Britain and for the City of London," Harrison told Reuters.
His committee's cross-party report, into the EU's plans to make the European Central Bank (ECB) supervisor for the currency area's 6,000 lenders from 2014, said the banking union threatened to fragment the wider EU single market and a powerful ECB must be made more accountable.
Echoing concerns from other non-euro zone countries such as Sweden, it said the rights of "out" states must be safeguarded.
The Treasury said Britain had been clear from the outset that a banking union must preserve the single market for the whole of the EU.
"Britain has consistently argued that a banking union is an essential part of a stable single currency, and ... the ECB is the right organisation to take on the central supervisory role for euro-area banks," a Treasury spokesman said.
Harrison said that with the 17 euro zone countries set to join the banking union, a majority of EU states, Britain's room for manoeuvre was, to some extent, limited. And he questioned whether Cameron could wield a veto if Britain did not secure adequate safeguards.
"We strongly support the principle of what's being proposed. I do not think a veto by David Cameron is going to help. In many ways it may take us further down the road of alienation."
The report outlines steps the government could take to safeguard London as Europe's biggest financial centre, some of which were already being lobbied for by Britain and its allies.
The committee said the European Banking Authority, which fleshes out rules for all the 27 member countries, must be buttressed to defend the single market.
"It is important to maintain the distinction between the EBA's role in setting rules across the EU and the ECB's role in supervising their operation within the single supervisory mechanism," the report said.
Editing by David Holmes