After fraught 2012, EU leaders hope for summit deal
* Europe's leaders hold sixth summit of 2012
* Banking union and next steps the focus of discussion
* Recession, Spain bailout, elections loom next year
By Luke Baker
BRUSSELS, Dec 13 (Reuters) - After a hectic year of crisis management, during which Greece had a close brush with the euro zone exit, European Union leaders aim to strengthen banking oversight and work on wider reforms at their sixth summit of 2012 starting on Thursday.
With Silvio Berlusconi vowing to contest an Italian election early next year, a full bailout of Spain still on the cards and a German general election in September casting a long shadow, 2013 promises to be the EU's fourth turbulent year in a row, and that's without mentioning Greece, Ireland or Portugal.
The immediate priority is to agree on the framework for a banking union across the euro zone and wider EU, putting the European Central Bank in charge of banking supervision to strengthen risk management.
A meeting of EU finance ministers in Brussels on Wednesday seemed close to a deal on which banks the ECB will oversee and how its powers will be checked, paving the way for leaders to approve it on Thursday or Friday.
If there is an agreement, and the European Parliament gives its assent, the ECB should start monitoring the biggest banks from March next year and be responsible for up to 6,000 banks from Jan. 1, 2014.
Completing such a complex process would be one of the EU's biggest achievements since the region's debt crisis erupted in early 2010, and might go some way to severing the so-called doom loop between indebted banks and shaky governments.
But it would only be the first step in building a banking union, that also entails creating a resolution authority and fund to wind up failed banks and coordinating deposit guarantee schemes across the euro zone to avoid bank runs.
The exercise is likely to take several years and officials see it is just the first part of a masterplan to bolster the architecture of the euro zone and prevent any repeat of a crisis that nearly tore the single currency project apart.
It promises to be a long and tortuous journey requiring political commitment from euro zone and non-euro members alike, something that countries such as Britain, with a restive Eurosceptic population, will find particularly stressful.
"I feel that this political will is still present, otherwise I would not be here anymore because I would have failed during the euro zone crisis," Herman Van Rompuy, the president of the European Council who chairs EU summits, said this week ahead of the award of the Nobel peace prize to the EU.
"The facts show that in this global world, in order to preserve our interests and promote our values, we need more European integration."
Each step towards closer union means a greater surrender of sovereignty by independent nations and spurs a political backlash, especially in times of economic hardship, social tension and high unemployment.
Van Rompuy and the presidents of the European Commission, the Eurogroup and the European Central Bank have put forward a bold blueprint for closer fiscal, economic and political integration in the euro zone alongside the banking union.
But German Chancellor Angela Merkel, Europe's most powerful leader, lowered expectation for progress on that agenda ahead of the summit, telling lawmakers on Tuesday that EU leaders should focus on steps that can be achieved within six months.
She is determined not to frighten German taxpayers with talk of eventually sharing more liability for banks or debts, and certainly wants to avoid any such issue until after the election in Germany, with campaigning already beginning to warm up.
Binding the euro zone more tightly together to underpin the currency union is driving some non-euro states such as Britain and Sweden to question their relationship with Europe, while others such as Poland are keen to stay close to the core.
The banking union - which neither Britain nor Sweden will join, even if they reluctantly let the ECB take responsibility for oversight - is just the first obstacle in a minefield ahead.
Asked about banking union on Wednesday, Sweden's finance minister said approval of it would mark a "sad day for Europe".
"There is a move now towards euro-banks, euro-taxes, euro-transfers, euro-commission," Anders Borg told reporters.
"We think those are steps in the wrong direction. It might be very popular among the Eurocrats, but I think there are very few Europeans actually wanting these developments."
While the debt crisis continues to weigh heavily on Europe's economy, leaders will have to navigate the pitfalls of electoral politics in Italy, Germany, Cyprus and elsewhere.
Italy is a particular concern if the next government rows back on any of the economic reforms put in place by technocrat Prime Minister Mario Monti, whose time in office has helped stabilise financial markets and stave off the crisis.
And after banking union, leaders must tackle the intricacies of closer fiscal integration, including proposals for setting up a separate budget known as a 'fiscal capacity' among the euro zone states -- a fund to help tackle one-off economic shocks.
That will involve more pooling of sovereignty and greater risk sharing, and may not be possible unless the EU's guiding treaty is opened up for amendments, a long and cumbersome process that no one wants until much further down the road.
Meanwhile, the original sovereign-debt problems in Greece and Portugal will not be fully resolved.
Greece's successful buying back of its own debt will help reduce its debt burden and will ensure that the next slice of emergency funds is released by the euro zone and International Monetary Fund, but there is a growing acknowledgement that Athens will need debt forgiveness in the years ahead.
In June and July, euro zone leaders came close to letting Greece go from the currency bloc. They resolved to keep it in, doing whatever it would take to get it back on its feet. Having taken that decision, they now have to bear the costs, however large and uncomfortable they may be.
Asked about the possibility of forgiving Greek debt, Dutch Prime Minister Mark Rutte, whose country remains triple-A rated and is reluctant to extend more aid to needy states, said it might have to be considered as soon as 2014.
"These are proposals which the Netherlands does not support but you cannot rule it out," he told parliament.
The admission hints at the weary resignation in some EU capitals - an acceptance that the crisis may no longer be acute, but it is here to stay and it will be a long and painful grind to overcome it.
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