Time runs short as Europe haggles over banking union reform
* Ministers gather for second day of negotiations
* Debate centres on scheme to close bad banks
* Spain's de Guindos hints at extra round of talks
BRUSSELS, March 11 (Reuters) - European ministers haggled over how to build a safety net for failing banks on Tuesday, redoubling efforts to avoid an embarrassing delay to the euro zone's centrepiece crisis reform.
The protracted talks over a scheme to close troubled lenders to complement European Central Bank supervision illustrates the politically charged nature of the plan to disentangle states and the banks from which they borrow.
An agreement between countries and the European Parliament had been pencilled in for this week but ministers entering the second day of talks on Tuesday conceded that it may take longer.
"This is important for the signal it sends to markets," said Spain's Economy Minister Luis de Guindos. "I hope we will make quite a bit of progress and if not, then next week we can finish the negotiation. We still have time."
Although signed off by states in December, the fine print governing how the new regime will work has reignited debate.
Meanwhile, time is running out to reach agreement with the parliament, which must approve the law before disbanding for May elections. Failure to seal a deal in time threatens further months of delay and uncertainty given an expected rise in the number of eurosceptic lawmakers after the poll.
Empowering the ECB to police banks as well as setting up an agency to shut troubled lenders alongside a fund to cover the costs - a project known as banking union - is the most ambitious political project in Europe since the euro.
Yet it means different things for the countries involved.
While France and Spain see it as a step towards sharing bank risks with Germany and advancing towards a common cost of borrowing across the euro zone, Berlin places greater emphasis on imposing losses on the creditors of laggard banks.
"We need to break the vicious circle between banking debt and sovereign debt," French Finance Minister Pierre Moscovici told reporters. "It's also a question of unifying the interest rates in the European Union."
His German counterpart, Wolfgang Schaeuble, emphasised the need for strict 'bail-in' rules to impose losses on bondholders and other creditors of a failing bank.
"It's clear that the bail-in rules apply," said Schaeuble. "They can't be weakened because it makes no sense to constantly talk about the taxpayer no longer having to foot the bill and then to begin not applying the rules about owners and creditors taking the risk at the start."
These rules are due to come into force in 2016 but Germany wants them to apply within the euro zone from when the ECB takes on its role of watchdog, at the end of this year.
That would herald tougher treatment of investors in banks found to be in poor health in ECB health checks.
The banking union, and the clean-up of lenders' books that will accompany it, is intended to restore banks' confidence in one another and boost lending across the currency bloc, helping foster growth in the 18 economies that use the euro.
New lending has been throttled by banks' efforts to raise capital and cut their risks during a recession, especially in countries hit hardest by the sovereign debt crisis.
The banking union is supposed to break the link between indebted states and the banks that buy their debt, treated in law as 'risk-free' despite Greece's default in all but name.
Euro zone banks now hold about 1.75 trillion euros of government debt, equivalent to 5.7 percent of their assets and the highest relative exposure since 2006, according to the European Central Bank. In Italy and Spain, roughly one in every 10 euros in the banking system is now on loan to governments.
At the heart of the dispute over the scheme is the complex process of closing a bank. Countries are reluctant to cede authority to Brussels and want a laborious system of checks before any decision to shut a bank can be taken.
EU finance ministers agreed in early December that a decision on closing down a bank in the euro zone would be taken by the board of a 'resolution' agency, but that it must then be approved by ministers.
The European Parliament, on the other hand, wants no involvement of EU ministers, arguing it politicizes the process and makes it cumbersome.
Governments and parliamentarians also disagree on how quickly to build up the fund to cover the costs of shutting a bank, and how soon countries should be able to dip into the pot. The fund will be filled by euro zone banks and is slated to reach around 55 billion euros ($76 billion).
Governments want the fund to reach full size over 10 years, while the parliament wants the fund to be fully available to all euro zone countries after just three years.
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