BRUSSELS/LONDON European Union countries could be obliged to bail out one another's struggling banks, according to a draft EU law that marks a big step towards greater EU financial integration likely to upset some members, particularly Germany.
Spain's banking troubles and the risk that a bank run in a country such as Greece could spread have given new impetus to delayed EU proposals for a law to deal with failing banks.
The European Commission, the EU's executive, will propose the rules on June 6, to grant local regulators what one official described as "aggressive intervention powers" to take control of stricken banks, break them up and impose losses on their bondholders.
If accepted by EU member countries, it would be a first step towards a pan-EU system of supervising and paying for the winding up of banks in difficulty, a vital element of the "banking union" the European Central Bank has called for.
The 156-page draft -- aimed at stopping banks from being "too big to fail" or their collapse wreaking widespread market havoc -- also maps out new powers for supervisors to "bail in" or impose losses on bondholders to shore up a lender's capital so that taxpayers are kept off the hook.
The law, which could come into effect as early as 2014, would introduce what some officials describe as an insolvency regime for banks in the EU.
It would also instruct countries to prepare for the collapse of a bank, by collecting the equivalent of 1 percent of bank deposits from an annual levy on banks.
That money would be held in reserve and used in an emergency to prop up a troubled bank with loans or guarantees.
The draft has been finalised shortly after European leaders, meeting in Brussels last week, agreed to examine ways to deepen integration in the European Union and euro zone, which could include closer cooperation on banking.
The draft does not suggest the immediate introduction of a single European Union fund to wind up or rehabilitate troubled banks, an approach favoured by the European Central Bank.
But the plan does break new ground on earlier drafts by proposing closer ties between national funds, a move towards the creation of a common EU scheme. That could oblige a scheme in Britain, for example, to lend to a fund in France, if a bank with operations in both countries were to face collapse.
Strict rules to pool national funds would likely encounter stiff opposition from countries such as Britain, which has argued that London - not Brussels - should have sole authority in deciding when to provide money to support banks.
The push towards a single resolution fund will also make Germany uncomfortable. It has opposed any attempt to use its financial muscle to prop up lenders in weak countries such as Spain.
Once the law has been approved, the Commission will in 2014 look at the next step and assess how a "more integrated framework" for winding down banks might be best achieved, the document said.
In the document, Commission officials wrote: "An effective resolution regime should avoid that the costs ... of a failing institution are borne by ...(the) taxpayer ... (and) should also ensure that large and systemic institutions can be resolved without jeopardising financial stability.
"Member states shall ensure that financing arrangements under their jurisdiction are obliged to lend to other financing arrangements within the union."
One EU official familiar with the text said: "It leaves some wiggle room, but there must be an arrangement to cooperate between countries."
Such proposals, which require the blessing of the EU's 27 states as well as the European Parliament, would stand little chance of success without the backing of Germany and Britain.
The latest draft also widens the scope to impose losses on creditors when a bank needs shoring up. During the crisis it was shareholders who took a hit and taxpayers also had to step in to keep lenders afloat.
An earlier version proposed that losses would only be imposed on a special category of bail-in bonds but the latest draft says losses should be imposed on "all liabilities" if writing down an ailing bank's shares and capital is insufficient to plug the financial hole.
About 10 percent of a bank's debt should be "bail-inable" and a supervisor's ability to impose losses should apply to existing and new bank debt from January 2018.
Speaking in Paris recently, Michel Barnier, the European Commissioner in charge of regulation, said the proposals included several steps.
"When supervisors identify a risk, there would be an early warning that could trigger a number of decisions including a ban on some banking activities, a ban on dividends being paid out and a change of management," he said.
"If the crisis becomes very serious and there is a need for an orderly bankruptcy, there would be a mechanism that could manage that. The bank would be able to manage it, with a resolution fund, creditors and shareholders."
(Additional reporting by Leigh Thomas in Paris.; Editing by Jane Merriman and Jon Loades-Carter)