* German finance minister sends mixed message on banking union
* Berlin's objections could derail scheme to tackle weak banks
* EU leaders made a commitment to banking union last June
* EU officials say a single agency is needed to close banks
By John O'Donnell
BRUSSELS, May 8 In June last year, European Union leaders made a great fanfare of committing to 'banking union', a three-step plan to shore up the region's 8,000 banks and prevent a repeat of the debt and financial crisis.
Eleven months on, deep cracks have emerged in the visions member states have of the scheme, with Germany in particular raising doubts about its overall feasibility although both it and France have promised progress by the end of next month.
While the first step - to create a single bank supervisor under the European Central Bank - looks set to be in place by mid-2014, a second pillar, a 'resolution' agency and fund to close failed banks, is in doubt. And there is little prospect that a third leg, a single deposit guarantee scheme, will ever see the light of day.
In recent weeks, German Finance Minister Wolfgang Schaeuble has sent mixed signals, saying at a meeting in Dublin in April that banking union could not be done without a change to the EU treaty, then saying on Tuesday he was committed to pushing ahead with it as far as possible under the existing treaty.
The net result, officials and analysts say, is that the final structure of banking union is likely to fall short of what EU leaders first envisaged, with potentially far-reaching implications for financial market stability.
In particular, market participants are worried that having supervision without a process for closing problem banks will leave banking union incomplete.
"The two, resolution and supervision, need to go together," said Simon Lewis, chief executive of the Association for Financial Markets in Europe, which lobbies on behalf of some of the globe's biggest investment banks.
"There is a lot riding on it in terms of a positive message for the stability of the system," he said.
One major challenge for policymakers is understanding precisely what Germany, the EU's largest and most powerful country, wants or is willing to accept from banking union.
Berlin is concerned that a single agency for resolving bank problems across the euro zone could result in a financial burden that falls chiefly on its shoulders, with German taxpayers ultimately liable.
With elections approaching in September, no politician would want to explain why Germany might have to foot the bill for a failed bank in another country.
Schaeuble said in Dublin that to establish a system for sharing liability, the EU treaty would have to be amended since there is no provision under existing law.
Officials in Berlin have argued that without a treaty change the potential use of German taxpayer money for winding down a bank in another euro zone state could be thrown out by the country's top legal body, the constitutional court.
But changing the treaty is a monumental procedure that can take years, meaning banking union would be greatly delayed, something that is a concern to France, Finland and many other EU countries, as well as to financial markets.
That may explain Schaeuble's verbal change of tack on Tuesday. After meeting French Finance Minister Pierre Moscovici in Berlin, Schaeuble said banking union was a "priority project" and that he was committed to working towards it as soon as possible.
"We must make the best of it on the basis of the current treaties," he said, suggesting a "network of national authorities" rather than a single resolution agency - something that would be little different to the patchwork of national supervisors that already failed in the crisis.
In other words, Germany's vision of banking union may well end at ECB supervision, with no shared resolution and certainly no single deposit guarantee scheme. That goes sharply against the view of France's Michel Barnier, the commissioner in charge of drafting the legislation that will underpin banking union.
"We need a (resolution) authority," Barnier said on Wednesday, referring to the original commitment of EU leaders.
"We need an authority that will guarantee a rapid decision ... and hopefully a common fund one day."
Without such an agency, Barnier and others in Brussels fear a return to a fragmented system of supervisors, fighting to protect their local interests when banks fold.
While Schaeuble's views have complicated efforts to craft banking union in the way EU leaders intended, he is not the only voice. The European Central Bank is growing impatient, having repeatedly said that banking union is essential for stability.
Speaking to the European Parliament on Wednesday, ECB policymaker Joerg Asmussen raised the case of Cyprus, where a banking meltdown forced a bailout, as a lesson in why forging a banking union is critical.
"The Cypriot case has been a salutary reminder of the importance of establishing banking union as swiftly as possible," said Asmussen, who was formerly Schaeuble's deputy.
"Only then, we will be able to break the negative interaction between sovereigns and their banking systems."
As with many pronouncements from Schaeuble, the first question on policymakers' lips was whether he was speaking for himself or if his views were shared by Chancellor Angela Merkel.
Either way, this time there is electoral arithmetic in play. With Merkel bidding for a third term in office, her acolytes don't want to be seen to support a scheme that could expose German taxpayers to losses.
"The potential fiscal consequences is their main concern," said one senior EU official involved in negotiations. "Elections are coming up in Germany," he said. "For now, you just have to keep a cool head."
Whether Berlin's stance on banking union softens thereafter remains one of the great imponderables in the euro zone's effort to draw a line under its crisis.