* Curbs on banks' use of ratings proposed on July 20
* Funds, insurers to follow by year end
* UK MEP Bowles says don't shoot the messenger
* Funds industry leery about costs for smaller players
By Huw Jones
PARIS, July 11 Banks in the European Union face curbs on how much they can depend on ratings from credit agencies to calculate the size of their capital safety cushions.
Michel Barnier, the EU's financial services chief, said he will make the proposals as part of his reform to bring EU bank capital requirements in line with a global accord known as Basel III that will increase the size of capital buffers.
"To limit overreliance, we will be strengthening the requirement for banks to carry out their own analysis of risk and not rely on external ratings in an automatic and mechanical way," Barnier said in a speech.
"We will also make other concrete proposals before the end of the year to limit over-reliance to deal with insurance, asset management and investment fund sectors," Barnier also told the European Securities and Markets Authority (ESMA).
The draft law is due to be published on July 20.
Peter De Proft, director general of the European Fund and Asset Management Association (EFAMA), told Reuters many investment firms already do their own credit analysis. "It will be more difficult for the smaller ones," De Proft said.
Moody's angered the EU this month by downgrading Portuguese debt despite the country securing an EU bailout.
Barnier said the "absolute minimum" must be to improve transparency in how agencies reach such decisions.
"That is why we should ask ourselves ... whether it is appropriate to allow sovereign ratings on countries which are subject to an internationally agreed programme," Barnier said.
Such a ban will be discussed by EU finance ministers shortly, he added.
Sharon Bowles, the UK Liberal chairman of the European Parliament's economic affairs committee, cautioned against seeing ratings agencies as the "fount of all evil" in the euro zone's debt crisis.
"I just think they are being shot as the bringer of bad news during the sovereign debt crisis. I am not entirely convinced the system is broken," Bowles told the ESMA meeting.
The continued zero-weighting of all sovereign debt when it comes to calculating bank capital has played a much more damaging role in the crisis by not allowing markets to discipline weaker debt, Bowles said.
The United States' Dodd-Frank Act is also forcing U.S. regulators to remove references to the use of credit ratings in determining bank capital.
It is part of a wider effort by the world's 20 leading economies (G20) to regulate credit rating agencies whose reputation was tarnished in the financial crisis for failing to warn investors in "toxic" securitised products fast enough.
Barnier will also sound out the G20 to see if it could also take fresh initiatives to regulate credit rating agencies due to the international nature of the business.
"We need to be more demanding when it comes to how credit rating agencies rate sovereign debt," Barnier said.
The EU has already approved two sets of laws to regulate the sector, forcing agencies to obtain authorisation to operate in the 27-nation area. The ESMA is expected to need several more months to issue licenses to the "Big Three" -- Moody's , Fitch and Standard & Poor's .
Barnier may also propose forcing agencies to allow a government "to check the accuracy of the data used by an agency in advance of any downgrading.
"European regulation could allow for investors to take agencies to court when there has been negligence or violation of applicable rules," Barnier added. "We have not closed the door to going further." (Editing by Greg Mahlich and David Holmes)