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BRUSSELS (Reuters) - Euro zone finance ministers will discuss on Monday which banks could be given direct aid from the bloc's bailout fund, embarking on a divisive debate that includes doubts about whether such a step should be taken.
Direct bank recapitalisation is meant to break the vicious circle between highly indebted governments that borrow more to recapitalise their banks which need support because they own bonds of those states. But the Eurogroup of euro zone ministers will confront deep divisions on the issue.
"There are still very divergent views between countries. The Eurogroup next week is just a beginning of the discussion," one euro zone official involved in the talks said. Others warned of the heavy cost of the European Stability Mechanism (ESM) recapitalising banks.
"This whole process will end with a compromise that nobody will be fully satisfied with," the official said, adding some progress could be made on the issue by March.
Euro zone leaders agreed last June that the bank-state loop must be broken and that the 500 billion euro ESM bailout fund should be able to buy bank equity to ease the debt burden on already struggling sovereigns.
The decision was mainly meant to help Spain, where the banking sector has been hit by the collapse of the property market and the government was struggling to regain market confidence amid a recession and record high unemployment.
Ireland, Greece and Portugal also have high hopes for the recapitalisation tool because they borrowed billions from the euro zone to recapitalise their banks.
But Germany, Finland and the Netherlands believe that the ESM should be allowed to take stakes only in banks that get into trouble in the future, once the European Central Bank becomes their supervisor in 2014. All previous problems are labelled "legacy" and should be dealt with by national governments, the three countries have said.
This would mean that such direct assistance for banks would only apply if banks ran into fresh difficulty in the future, dramatically cutting the chance of such direct aid.
Such an interpretation could disappoint those who had been under the impression that while the possibility of recapitalisation may open only in a year or so, it could still be applied, retroactively, to banks that are in trouble now.
"The whole point of direct recapitalisation was to solve the current crisis, not a possible next one. That was the spirit of the deal - that Spain would get the recapitalisation loan off its books," a senior euro zone official said.
But officials also said the issue lost much of its urgency because Spanish bank recapitalisation needs turned out much lower than expected and the European Central Bank restored confidence in Spanish debt by declaring it would buy a potentially unlimited amount of it, if Spain asked.
Further removing the need to hurry, euro zone leaders gave ministers until June 2013 to sort out the operational details of direct recapitalisation.
Countries have also been warned by officials of the high costs that come with any direct aid by the ESM for banks because of the risks attached to becoming a shareholder.
"Essentially, bank equities are a more expensive asset to hold than member states' bonds - you would have to put more capital aside," said a second.
"So the question is whether you have the capacity to do a lot of it. It's difficult to see how you would underwrite whole banking systems. It's helpful because it breaks the link between banks and sovereigns but it's expensive."
A second official said: "Banking recapitalisation should be reduced to as little as possible."
Adding to the complexity is the fact that if the ESM becomes the owner of banks, it could get sucked into the problems of managing those institutions, such as addressing how the different banks it owns compete with one another.
The prevailing view is that the ESM should only step in to recapitalise a financial institution as a last resort, when the bank has failed to raise the money from private investors and the government is not fiscal strong enough to help either.
But the consensus seems to end here. Some officials would like to see the most risky assets of the troubled banks moved to a "bad bank", which would then be the responsibility of a government, while the ESM recapitalised the viable rest.
Others point out that after a bank shifts loans at risk of non-payment to a bad bank, it is likely to become attractive as a business again, so there should be no obstacle to seeking capital from private investors or even the government.
Reporting By Jan Strupczewski