(Adds context and background)
By Jan Strupczewski and Martin Santa
THE HAGUE Feb 13 Banks that fail this year's European health checks badly should be closed down, the head of the euro zone finance ministers group said on Thursday.
Before the European Central Bank takes over banking supervision in November as part of a broader push towards closer integration of the financial system, it will conduct a comprehensive assessment of the euro zone's 128 largest banks.
Daniele Nouy, the head of the new banking watchdog, said earlier this week that if any of the participating banks failed the assessment they could be wound down, and that merging them in order to save them was not a solution.
"I was very happy about what Daniele Nouy said ... that if banks come out in a very bad shape we will simply have to close them down," Jeroen Dijsselbloem, who is also Dutch finance minister, told the Reuters Euro Zone Summit in an interview.
"Her point was that we are going to do it the tough way. And that is the signal all of us need - the banks needed to get that signal, the financial markets need that signal and the citizens in Europe need to get that signal," he said.
Dijsselbloem said it was important for the euro zone to get its banks into shape quickly because they were crucial to the bloc's economic recovery, adding that lenders were already taking action without waiting for the results of the review.
"I don't know what the outcome of the asset quality review is going to be but ... a sensible bank is not going to sit and wait for the outcome. It is going to think how it can pro-actively deal with problems and I think this is going on as we speak," he said.
The review is part of euro zone preparations to set up a banking union, in which the ECB would supervise all banks. Policymakers believe that will unclog credit to the economy and boost growth.
The banking union would also entail a mechanism to shut failing lenders and a joint pool of money to cover the cost.
Dijsselbloem said completing negotiations on how to close down banks and pay for it was all the more important ahead of European Parliament elections in May, because Eurosceptic parties on the left and right are gaining support.
"People are interested in results, they want to see that what we do in Europe serves a good purpose. Building a banking union to make the banks once again support the economy, instead of the other way around - that's the results the people want to see," Dijsselbloem said.
Completing banking union depends on reaching an agreement between the European Parliament and euro zone governments on who will decide if a bank is to be closed and who should foot the bill.
Closures are to be funded from contributions from banks operating in all euro zone countries, which will reach a full capacity of 55 billion euros ($75 billion) after 10 years, when all the funds will be pooled together.
Until then, the costs will have to be covered mainly by the home country. To break that "doom loop", the ECB and the European Parliament have called for pooling the resolution funds in five years rather than 10.
Dijsselbloem said that would be tough.
"It going to be hard to start again or to change it radically, so I don't expect there will be radical changes there," he said.
He said 55 billion euros was a sufficient backstop because before the fund could be used to pay for the closure of a bank, all its shareholders, bondholders and even major depositors would have to lose money.
"We think that the 55 billion is enough. If you put the fund at the start (of the resolution process) it will not be enough, but it is not at the front, it is at the end of the process," Dijsselbloem said. ($1 = 0.7359 euros) (Editing by Mike Peacock and Robin Pomeroy)