* Germany wants rules in 2015 to push bank losses oninvestors
* EU lawmaker Hokmark warns big depositors can also be hit
* Tough regime could be in place for ECB bank shake-out
By John O'Donnell
BRUSSELS, Nov 13 (Reuters) - Market euphoria and soaringdemand for European bank debt could be brought back down toearth if the European Union pushes ahead with the earlyintroduction of rules allowing Cyprus-style raids on bankcreditors and big depositors
Following demands from Germany, the European Union law toraid the bondholders and savers of failing banks could takeeffect as soon as January 2015, three years earlier than plannedand in time to hit banks exposed by European Central Bank testsnext year.
An early start date has won support from the ECB, uneasyover banks' reliance on its support, and this week JensWeidmann, the president of Germany's Bundesbank, became thelatest policy maker to join the chorus of support.
Investors have been buying up bank bonds to make up forotherwise feeble investment returns in an era of record lowinterest rates. The market mood has picked up so much that hedgefunds and others are even ready to invest in Greece, the countryat the deep end of the euro zone debt crisis.
The so-called 'bail-in' of creditors could, however, revivethe worst memories of the debt crisis and mark the currencybloc's biggest upset since a rescue of Cyprus earlier this yearbroke a taboo by imposing losses on big savers.
"Animal spirits are back," said Jacob Kirkegaard ofWashington think-tank the Peterson Institute For InternationalEconomics. "But this market is not going to last. The situationremains very, very fragile."
The prospect of the new law has done little to curbenthusiasm for bank bonds; Spanish banks have sold 22 billioneuros ($29.5 billion) of unsecured bonds since the start of lastyear. Nor has it prompted large savers to move their cash tosafe havens.
"The market may assume that there is not going to bebail-in, that when the going gets tough, the governments and theECB will cave in," said Kirkegaard. "They will have a rudeawakening."
The power to impose losses on bank creditors is the mostmarket-sensitive part of banking union. Germany wants its earlyintroduction in return for giving its full backing for theproject to police and support banks in the euro zone.
Berlin wants the rules available for next year's ECB healthchecks, allowing losses on bondholders or large depositors ofbanks with skeletons in their closet.
"I hope that serious investors know what they are investingin," said Gunnar Hokmark, a member of the European Parliamentwho plays a central role in shaping the new law.
"Everything is to be seen as bail-in-able. Depositors are,in the end, bail-in-able. If anyone would be surprised by that,they have been away from the debate for quite a long time."
Originally pencilled in for 2018, these rules will befinalised and possibly accelerated by European Union countriesand the bloc's parliament in the coming weeks.
There is a lot at stake. Banks across the 17 countries inthe euro zone have 860 billion euros of unsecured bonds, withGerman banks accounting for almost 200 billion euros, accordingto Thomson Reuters data.
Banks in Spain and Ireland are selling billions of euros ofbonds - Irish banks have issued almost 750 million euros ofbonds over roughly the past year - despite uncertainty overtheir true health.
Investor enthusiasm has not been dimmed by memories of thebanking problems that forced both countries to ask forinternational emergency aid.
These investors would be among the first in line for losses,if problems are uncovered. And yet, the cost to banks of sellingsuch debt is dropping to levels not seen since 2010.
"If you look at the pricing of bank risk across the euroarea, that market is sniffing glue," said Willem Buiter, Citi'schief economist.
The price for banks of a credit default swap - a form ofinsurance to cover non-payment of debt - is roughly one thirdthe level it was at the peak of the crisis in 2011.
It is not only bondholders at risk. Savers with more than100,000 euros at a bank that is closed or revamped also stand tolose out, but depositors, too, appear so sanguine that theyhaven't troubled to move their money to safe havens such asGermany.
The volume of deposits in countries such as Greece areholding steady, according to ECB data, just months after capitalcontrols were introduced in neighbouring Cyprus.
Savers in Slovenia, where the government is required to helpbanks weakened by years of reckless lending, are equally calm.After modest falls in deposits after Cyprus, the volume is nowholding steady.
Yet ratings agency Fitch estimates the cost of rescuingSlovenia's banks at 4.6 billion euros - probably too much forthe country to manage alone, without a bailout or other radicalmeasures.
"Deposits in countries such as Greece or Slovenia areirrationally sticky," said Citi's Buiter. "Many euro areagovernments have empty pockets or are politically unable to helptheir banks further without bank creditor bail-in."
The size of banks' potential liabilities have long overtakengovernment's ability to save them.
ECB data shows that euro zone banks have issued more than3.8 trillion euros of home loans - more than a third of thebloc's output and one-and-a-half times the German economy.
This helps explain why Germany, the euro zone's biggesteconomy and the country most likely to be called on to bear thebrunt of bank clean-up costs, wants the tough rules early.
Last week, the ECB came out in favour of an earlierintroduction of bail-in, playing down concerns that this wouldexacerbate banks' funding difficulties. Moving forward the date,it said, would provide investors with certainty.
"Markets are complacent and believe the European crisis isover," said Garry Schinasi, a former official with theInternational Monetary Fund who now advises governments.
"But the banking system is still fragile in Europe. No onereally knows how bad it is."
- European Union
- European Central Bank