* EU finance ministers meet on Tuesday to decide new bank rules
* Britain isolated as it struggles to keep autonomy
By John O‘Donnell and Robin Emmott
BRUSSELS, May 14 (Reuters) - Isolated in Europe, Britain has little choice but to back down on its demand for changes to draft EU banking rules it had called idiotic.
European Union finance ministers meeting on Tuesday will seek to agree rules on the capital that banks across the 27-member bloc must raise in order to cover their risks, a measure designed to avoid another financial crisis.
Britain wants the freedom to impose higher standards on banks and fears the loss of control over its financial sector. Other countries, such as France, had argued for a single standard across Europe.
“Britain is now left standing alone and its reluctance to compromise has only served to strengthen the resolve of others to accept this deal,” said one EU diplomat.
Despite being unable to win all the concessions it wants, there are signs Britain is ready to back down, according to another diplomat familiar with Britain’s position.
Struggling with the cost of bailing out banks that foundered early in the financial crisis, Britain wants higher capital limits to avoid any future tax-payer funded bank rescues. It is also wary of others setting the rules for Europe’s biggest financial centre.
Some countries want to avoid burdening banks, weakened by the eurozone debt crisis. The European Commission, the EU executive, fears that if banks in some countries are told to raise more capital, that will reduce badly needed lending to neighbouring states.
Banks in countries with tougher rules could also be seen as safer and suck in deposits from elsewhere.
The rules, in line with the Basel III regime laid down by international regulators, force banks to hold capital to cover risks such as the unpaid home loans that brought down banks in Ireland and threaten Spanish lenders.
Talks on bank capital ended acrimoniously in early May after Britain’s finance minister, George Osborne, said the draft law would make him “look like an idiot” if he put his name to it.
But if he seeks to block the deal on Tuesday, he faces likely defeat.
“There has always been an unwritten gentlemen’s agreement that you don’t isolate Germany on cars, France on agriculture and Britain on financial services,” Charles Grant, director of the Centre for European Reform, a British think tank, said.
“But the agreement not to outvote the UK seems to be ending on the capital requirements directive,” Grant said.
Osborne had argued that London should decide how to ensure its banks are safe because it would bear the cost of a bailout - a rare case of Britain demanding tougher regulation when it usually seeks to shield London from EU rules.
Britain has won some concessions. Under the compromise, it would be able to raise a bank’s minimum capital, from the 7 percent core tier one ratio set in Basel, to 12 percent.
But beyond this, it would need approval from the European Commission, something it had fought to change.
Britain’s two biggest allies on the issue, Poland and Sweden, agreed to the compromise, leaving Osborne little choice but to follow.
Holding out might please those in Britain’s ruling Conservative party who would like to leave the European Union.
But a further stand against the capital rules, due to take effect next year, could deepen Britain’s isolation in Europe after Prime Minister David Cameron blocked plans in December to change an EU treaty to enforce budget controls in the euro zone.
In a sign that Britain’s government was anticipating internal criticism over a deal, British officials last week said the suggested compromise would not hamper its freedom to reform banking.
Even once the finance ministers vote on Tuesday, the rules still have to win the backing of the European Parliament, where some were antagonised by Cameron’s protest over a deal on a budget pact for the euro zone.
Britain might gain greater scope to influence the argument in parliament if, by agreeing to a deal, it can win over some of those still sceptical of its approach.
“It’s felt that Britain is not a part of the EU concept and that creates problems for them when they really want to be a part of what is going on,” said Ollie Schmidt, a Swedish liberal who is among leading lawmakers on financial reform in the parliament. “That’s dangerous.”