BRUSSELS (Reuters) - European finance ministers will pledge on Friday to stand by any banks that are exposed as dangerously weak by health checks next year, but Germany does not want euro zone money to be used for the clean-up.
Ministers will make their joint statement to reassure investors following a meeting in Brussels, taking Europe a step closer to coming clean on the banking problems that have dogged it for more than half a decade.
It sets the scene for bank health tests next year - first by the European Central Bank and then by regulators across the wider European Union - that are likely to reveal losses on loans and pose the question of who pays for the clean-up.
According to a draft obtained by Reuters, EU ministers will underline their readiness to move quickly to tackle problems that are uncovered in the checks.
The ministers will say that any bank under the ECB's watch will have "national backstops" in place in time for the tests.
But while countries agree in principle on the need to support banks, Germany is worried that it will be left to shoulder the burden if weak countries turn to the euro zone's emergency fund for support.
A euro zone backstop is central to building a banking union to stop a repeat of the case of Ireland, which buckled under the weight of its bank debts. It is a key demand of some of Europe's biggest countries - France, Italy and Spain.
Earlier this year, countries agreed that the euro zone's rescue fund, the European Stability Mechanism, could provide direct assistance to banks, rather than by lending to their governments. But Germany has now called that into question.
"France continues to believe that we ... must not exclude direct recapitalization by the European Stability Mechanism as a last resort," France's Finance Minister Pierre Moscovici told reporters at the first day of the meeting.
Speaking just yards away, however, Wolfgang Schaeuble, Germany's finance minister, poured cold water on that idea.
"The German legal position rules it out now," he said. "That's well known. I don't know if everyone has registered that."
Furthermore, Germany does not want the ESM to lend to any other fund set up to close down or salvage a weak bank.
The discussions in Brussels are part of wider negotiations on setting up a so-called banking union, Europe's most ambitious reform since the start of the euro currency.
It would see the ECB policing lenders and should ultimately form a united front across the euro zone to back weakling banks or close them down.
But the path to banking union is strewn with obstacles, and time is running out for the ministers to strike agreement by their self-imposed deadline of the end of the year. One of the most sensitive questions is how to deal with banks so badly wounded that they need to be closed.
"We won't put a knife to our throats," said Moscovici. "It's unlikely we will reach agreement tomorrow."
The first pillar of banking union will see the ECB take on the supervision of big banks towards the end of next year.
In tandem, it will conduct a review of their balance sheets, laying the foundation for the wider tests across the European Union.
Rating agency Standard & Poor's believes that the bank capital shortfall in the euro zone may total slightly more than 1 per cent of the region's economic output, or about 95 billion euros.
But before such a test result can be announced, the question of who pays for the costs of salvaging weak banks or shutting those not worth saving must be answered.
In their statement, ministers will say that if the tests show a bank is short of capital, its shareholders and other investors will be asked to raise it.
Very few countries have special funds for that purpose, so the ministers have to make sure that at least legislation is in place for them to inject capital.
Ministers will make clear that government help will only be possible if private funds are not available.
In other words, state help will come at a heavy cost by imposing losses on shareholders and junior bondholders, changing a bank's management and capping salaries and bonuses.
In time, possibly as soon as 2015, senior bondholders and even depositors with more than 100,000 euros in a failing bank, will be forced to take losses.