UPDATE 1-Germany says further steps needed before banks tap ESM
* Ministers' talks reveal deep divide on banking union
* Germany's Schaeuble says supervision not enough for direct bank aid
* France pushes for prompt action
NICOSIA, Sept 15 (Reuters) - Handing bank oversight to the European Central Bank is not in itself sufficient to allow the euro zone's rescue fund to directly assist banks, Germany's Finance Minister said, warning he expected no such deal on supervision in 2012.
Wolfgang Schaeuble made the comments after talks between EU finance ministers on Saturday exposed deep divisions about a proposed banking union. That may disappoint investors who had been pinning hopes on a pledge by euro zone leaders to agree sweeping new powers for the ECB in 2012.
This in turn had been expected to unlock the possibility of direct aid to banks from the euro zone's rescue fund, the European Stability Mechanism (ESM), for countries such as Spain or Ireland.
"We have the declaration of the heads of governments of the euro zone that European banking supervision is a necessary but not sufficient prerequisite," Schaeuble told reporters after the ministers' meeting in Cyprus. "The rules of the ESM remain."
He said any country that is home to troubled banks would still need to apply for an adjustment programme through the ESM.
The remarks contrasted with those of French Finance Minister Pierre Moscovici, who called for quick action and underlined the commitment by euro zone leaders to reach a deal this year.
"There are many questions on all of its aspects: the calendar for implementation, the scope of supervision, the role of the European Central Bank, the mechanism for supervision," Moscovici told reporters.
"These differences do not appear insurmountable at all to me. I am convinced that we will get there before the end of 2012: both because it's our duty and we have the possibility to do so," he said.
France's economic growth has ground to a halt since late last year and its banks have investments in struggling countries such as Greece.
Talks among EU finance ministers laid bare deep divisions not only among euro zone countries but also with many neighbouring states, worried that the ECB's power could impinge on their banks.
Schaeuble reiterated his criticism of elements of the proposal, cautioning against expectations that a deal could be reached by the end of the year.
"I don't see that there can be direct recapitalisation through the European Stability Mechanism already by January 1," he said.
Germany, which is keen to retain primary oversight for its regional savings and cooperative banks, had questioned whether the ECB should get the authority to supervise all 6,000 banks in the euro zone, arguing that it would overstretch the bank.
Officials in Berlin say it would be better to proceed more slowly with the reforms to ensure a water-tight system.
Sweden underscored the depth of the division. "There is a large number of countries that are very worried," said Finance Minister Anders Borg, saying Poland, the Czech Republic and the Nordic countries shared his concerns.
"There are very few countries outside (the euro) that think this is a balanced solution."
Establishing a common framework for dealing with problem banks would mark a departure from the previously haphazard approach taken by the euro zone's 17 members that has frustrated investors and helped drive up borrowing costs for weaker states.
A banking union foresees three steps: the ECB getting the power to monitor all euro zone banks and others in the wider EU that agree to the oversight; the establishment of a fund to close troubled banks; and a fully fledged scheme to protect citizens' deposits across the euro zone.
Given that day-to-day supervision of banks would remain the task of national regulators, some officials suspect that Berlin's real concern is that a banking union would see it paying the costs of propping up lenders in weak countries.
Joerg Asmussen, a member of the ECB's Executive Board that forms the nucleus of its policymaking, earlier warned that a banking union could not work without a fund paid for by industry to cover the cost of closing banks and a deposit protection scheme.
Experts from think tank Bruegel delivered a similar message to ministers on Friday.
The close ties between governments and the banks they supervised and on whom they also relied to buy their debt, has dragged both ever deeper into crisis.
A banking union would break this link by making the policing of banks supranational and establishing central schemes paid into collectively to cover the costs of closing failed lenders.
For the plan to work, however, it will require countries to surrender a degree of sovereignty over banking supervision, which has long been a national responsibility.
But even those who stay outside the framework can be affected. Hungary, many of whose banks are owned by banks in the euro zone and who would in future be supervised by the ECB, is worried they will lose control of their lenders.
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