* UK's Osborne blocks agreement on EU bank rules
* Lawmakers, analysts fault EU approach on capital
* Division over rules centre on British demand for autonomy
By John O'Donnell
BRUSSELS, May 3 When Britain's George Osborne told other EU finance ministers at a negotiating table that their plans for bank capital rules would make him "look like an idiot", his colleagues may have been exasperated by his un-European lack of tact.
But behind the scenes, some EU lawmakers say he had a point.
Despite 15 hours of marathon talks which ran until early on Thursday morning, Britain refused to back a 700-page draft law, weighing 1.5 kg (3.3 pounds) and designed to introduce globally agreed standards for European banks.
Osborne said the draft fell short of what had been agreed by the Basel committee of regulators. Britain has demanded that the Bank of England be allowed to impose higher capital requirements on British banks than called for in the European law. Poland and Sweden made similar demands.
"I am not prepared to go out there and say something that is going to make me look like an idiot five minutes later," Osborne said during a televised portion of the talks.
"He is right," said Sven Giegold, a German member of the European Parliament's economic and monetary affairs committee, as exhausted diplomats took stock of the failure on Thursday.
"If you have relatively weak capital requirements, the consequence of this is that countries such as the UK will demand an opt-out."
Not all are so full of praise. Many diplomats are angry about what they see as Britain's demand for special treatment.
"There was a real sense of frustration that we couldn't come to a deal," said one diplomat, who attended the talks among ministers. "Some felt Osborne came with a spoiler strategy."
Finance ministers will make a new attempt to end the deadlock when they meet on May 15, aiming to pave the way for negotiations with the European Parliament to finalise the draft law.
Britain, however, believes its demand for leeway to impose higher capital standards on its banks is necessary to protect taxpayers, who would be saddled with any bailout if the new rules are not tight enough to keep banks afloat.
"They certainly have a point," said Karel Lannoo, chief executive of the Centre for European Policy Studies, a Brussels think tank. "There has been a watering down of Basel."
In particular, both Giegold and Lannoo single out what they describe as a failure to adopt a leverage ratio, a pure measure of a bank's lending over the capital it holds.
"There was a clear demand for a leverage ratio," said Lannoo. "What we have now is a promise to do something by 2018."
The European Commission, which wrote the draft, says it has stuck to the recommendations of the Basel committee.
"This was a copy and paste of what was asked for," one Commission official said.
Lannoo, however, said French and German banks stood to benefit most from the so-called risk-weighting of assets that will now be used in deciding how much capital banks must hold.
A leverage ratio, he said, would have been a purer measure of risk-taking at banks, making them more transparent and ultimately safer. The complexity of the subject allowed much to go unchallenged, he said.
"If you have something which is complex, it allows you to hide. This is something that is crucial to the banking sector, but there is hardly any discussion about it. It is a scandal."
Britain also objects to what it sees as a watering down of Basel standards in EU law if it were to recognise a unique form of shareholder capital often used for German regional landesbanks that does not always absorb operational losses.
It also opposes any use of an insurers' capital in a bank-insurance conglomerate to support the bank in such a group.
Such reservations strike a chord with Nicolas Veron, a regulatory expert with Brussels-based think tank Bruegel.
"The EU was a strong promoter of internationally consistent financial standards before the crisis. The crisis has changed the dynamics between the EU and global standard-setters," he said.
"In practice the EU now looks much more like the U.S.: in favour of global standards when it 'likes' them and not in favour when it 'dislikes' them."
Many suspect Britain's true concern is a loss of its autonomy in controlling the City of London, Europe's top financial centre, which accounts for almost 10 percent of Britain's domestic economy.
Restrictive EU rules could tie the hands of the Bank of England if it chose to impose higher capital standards on local banks.
Osborne also faces calls from eurosceptics within his own Conservative party - some of whom advocate cutting Britain's ties to the European Union - to resist surrendering further power to Brussels.
While some in the European Parliament backed calls for Britain's demands for leeway to impose tighter standards, others were sceptical.
"There appears to be a large consensus that national supervisory authorities can impose additional capital buffers," said parliamentarian Othmar Karas, an Austrian who will take a leading role in negotiating a position within the European Parliament.
"I demand a maximum harmonisation of the new rules for banks and avoiding countries acting on their own."
Udo Bullman, a German member of the European parliament, said the challenge was to create a practical solution.
"This is not about watering down Basel," said Bullman, a German socialist who will also play a role in negotiating the parliament's position. "We are looking for a workable structure. Add-ons (granting flexibility) can be part of that, but there must be European controls." (Additional reporting by Robin Emmott; Editing by Rex Merrifield and Peter Graff)