* Dealing with bust banks crucial step in banking union
* France's Moscovici warns against 'weak' reform
* Euro zone ministers wrestle with who pays for clean-up
By John O'Donnell and Robin Emmott
LUXEMBOURG, Oct 14 (Reuters) - The euro zone wrestled onMonday with the question of who should pay for a clean-up ofbust banks, as Franco-German divisions cast a cloud over effortsto seal a landmark reform and draw a line under the region'sfinancial crisis.
As Spain and Ireland prepare to end their reliance oninternational aid that shored up their banks, finance ministerssought to devise a long-term action plan to deal with problemslikely to be uncovered in bank health checks next year.
Issues remained over how much the euro zone's rescue fund,the European Stability Mechanism, will be able to help, as wellas over how to build a single banking framework for the bloc andresolve future problems together in a banking union.
"It is a priority, an essential project," France's FinanceMinister Pierre Moscovici told reporters after the meeting inLuxembourg. "A weak banking union is not a banking union."
France is leading a group including Spain and Italy indemanding that the ESM, established to provide financial help toeuro zone governments, act as a clear backstop for unstablebanks in the euro area, in time for when the European CentralBank's health test results are announced some time in 2014.
Germany, Europe's largest economy, along with theNetherlands and Finland want conditions attached to any ESMinvolvement to prevent the clean-up costs being foisted on them.
"France defends the possibility of using the EuropeanStability Mechanism as a backstop within the banking union,"Moscovici said.
Bank health checks by the European Central Bank are acritical step in establishing a single banking framework for theeuro zone, giving credibility to ECB supervision and paving theway for the bloc to cooperate on saving failing banks.
The divisions in the 17-nation currency area were underlinedby Moscovici's blunt criticism of Germany before the meeting.
In a new book to be published this week, he accused Berlinof holding up progress on banking union to protect its own'strange' financial system of regional banks that are "deeplyintertwined ... with local political circles".
"What Germany fears ... is ... a loss of political controlover its banks, which means in the final analysis a loss ofsovereignty," Moscovici wrote in "Battles to resurrect France".
Germany's finance minister, Wolfgang Schaeuble, was notpresent because of talks to form a new German government.
To complicate matters further, Britain, which is outside theeuro zone, has repeatedly refused to sign off on the firstpillar of banking union, the supervision.
London has demanded assurances that Britain will not faceinterference from the ECB-led banking union.
"DON'T SPEAK LOOSELY"
Asked to outline the hurdles that remain on banking union,Jeroen Dijsselbloem, who chaired the meeting of euro zonefinance ministers, replied: "How much time do you have?" beforelisting a range of issues such as establishing a fund and agencyto close or salvage troubled banks.
The acrimony between the euro zone's two largest economies,France and Germany, will complicate EU efforts to strike a dealby December on how to salvage failed banks, as set out byEurope's leaders to give time for the agreement to be signedinto EU law in 2014.
A failure to do so would put the ECB out on a limb when itbegins supervision of euro zone banks late next year, withoutany means to shut or save banks in trouble.
Although nobody knows the true scale of potential losses atEurope's banks, the International Monetary Fund hinted at theenormity of the problem this month, saying that Spanish andItalian banks face 230 billion euros ($310 billion) of lossesalone on credit to companies in the next two years.
Dijsselbloem said ESM direct aid for banks would only beavailable under strict conditions, and could not say if thispossibility would be ready in time for the bank health checks.
Ending their meeting, the ministers restated the urgent needfor progress but acknowledged the breadth of differences thatmust be overcome. The debate continues on Tuesday when ministersfrom the wider European Union gather.
With the euro zone barely out of recession, a failure to putaside money to deal with the problems revealed could rattlefragile investor confidence and compound borrowing difficultiesfor companies, potentially killing off the meek recovery.
The discord helps explain why five years after the UnitedStates demanded its big banks take on new capital to reassureinvestors, Europe is still struggling to impose order on itsfinancial system, having given emergency aid to five countries.
The debate also comes at a delicate moment for the eurozone, with Spain and Ireland planning to end their reliance onthe aid that was given to save their banks. Question marksremain over both countries and the true health of their banks.
Ireland's banks, which nearly drove the country intobankruptcy three years ago, face further losses, with increasingnumbers of homeowners falling behind in repaying their loans asthe economy continues to stagnate.
Olli Rehn, the EU's Economic and Monetary AffairsCommissioner, sought to play down those concerns, however,saying: "Let's not jump the gun. Let's first establish thefacts... And in the meantime, don't speak loosely."
- Politics & Government
- Pierre Moscovici
- European Stability Mechanism