Anxious EU Ministers Edge Towards Bank Rules Deal

European finance ministers edged closer on Tuesday to breaking a deadlock on tougher capital standards for banks, a reform designed to prevent another financial crisis but which has exposed deep rifts between Britain and the rest of the EU.

Britain refused to back a draft of the law earlier this month, when its finance minister, George Osborne, accused fellow ministers of trying to water down the new rules to a point where they would make him "look like an idiot".

But he struck a more conciliatory tone on Tuesday, acknowledging the depth of the crisis in the euro zone that has, in recent days, driven Spain to take over major lender Bankia and prompted a sweeping downgrade of Italy's banks by rating agency Moody's.

The deal would be a milestone in deciding how much capital lenders should have to set aside to cover risks, one of the central questions raised by a five-year-long financial crisis that has toppled dozens of banks in Europe.

In recent days, Osborne had been alone among the 27 European Union finance ministers in calling for further changes to a law that introduces rules written by international regulators for the European Union's 8,300 banks next year.

Entering a finance ministers' meeting on Tuesday, he signalled a breakthrough was within reach.

"This is a time of considerable uncertainty in the euro zone economies," he said.

"We are reaching a point where we have got to make a decision to see the euro zone stand behind their currency. A very important part of that is strengthening the entire European banking system and that is what we intend to do today."

Anticipating criticism that London was climbing down on earlier demands, British officials have privately emphasised that any accord would leave them full flexibility to increase bank's capital cushions beyond the scope of the pan-European agreement without interference from Brussels.

Finding compromise is also necessary to avert a further deterioration in relations between Britain and the rest of Europe after Prime Minister David Cameron last year blocked plans in December to change an EU treaty to enforce budget controls, alienating the rest of the bloc.

BRUSSELS OR LONDON?

Margrethe Vestager, the economy minister of Denmark - which as holder of the rotating EU presidency plays a central role in negotiating deals - said she believed an accord was within reach.

"We hope to get a deal," she said. "(Going back to) the drawing board is not an attractive option."

Higher capital buffers strengthen banks to withstand shocks, such as the slump in property prices or recession now hitting Spain. Banks with higher-than-average capital, such as Switzerland's UBS, attract deposits.

If financial markets shunned a particular country in the bloc and it needed emergency funding, for example, more capital would help banks resist contagion.

Osborne, however, is concerned about what he sees as the creeping powers of Brussels. He wants to defend Britain's autonomy in controlling financial services, which account for around 9 percent of its economy.

Having bankrolled the 46-billion-pound rescue of Royal Bank of Scotland, the world's biggest bailout during the financial crisis, Britain has fought for the freedom to set higher capital standards than the EU norm.

Osborne has argued that Britain - not the EU's executive Commission - should decide how to ensure its banks are safe, as it would bear the financial consequences of a bailout.

Under one model, Britain would be able to raise a bank's minimum capital from the 7 percent core tier 1 capital ratio - set by the so-called Basel III code - to 12 percent. Above this, it would need approval from the European Commission.

Such a deal could irritate anti-EU members of Osborne's Conservative Party, which rules Britain in a coalition government.

Osborne is pushing for a commitment from other countries not to interfere with its banking reforms which will force banks to hold more capital than under the EU agreement.

In exchange, he may however have to drop objections to measures including the recognition of a unique form of shareholder capital often used for German regional landesbanks that he believes waters down the Basel regulatory standards on bank standards in EU law.

Countries will now have to negotiate a final version of the bank law with the European Parliament. Many of its key members want to have more EU control over how countries levy additional capital demands.

Europe's capital regime, when decided, will be closely studied in the United States and may influence how policymakers there interpret the Basel norms. (Reporting by John O'Donnell; editing by Rex Merrifield, John Stonestreet)