The cost of closing down a euro zone bank will initially be borne almost fully by its home country, but the obligations of euro zone partners will gradually rise to be shared equitably after 10 years, under the terms of an EU proposal seen by Reuters on Saturday.

The proposal, prepared by Lithuania which holds the rotating presidency of the European Union, will be discussed at an extraordinary meeting of senior EU officials on Monday, December 16.

After a financial storm that toppled banks and dragged down states from Ireland to Spain, countries are considering a fresh blueprint outlining what to do when a bank fails, a critical second pillar of a wider reform dubbed “banking union”.

Sealing a deal ahead of a meeting of an EU summit in Brussels December 19-20 will allow Germany’s Chancellor Angela Merkel and her peers to trumpet an important overhaul of banking, although their readiness to share the costs of failed lenders, a central tenet of banking union, may fall short of what had been hoped.

Under the proposal, the costs of closing down a bank in the first year of operation would be fully covered by a fund set up by the home country where the bank resides.

Such funds would be set up in every euro zone country and each would be filled from fees paid in by banks in the respective countries, amounting each year to 0.1 percent of all covered deposits they hold.

Such funds would reach their full size of 1 percent of all covered deposits after 10 years, but in the first year each would have only 0.1 percent of all covered deposits in a euro zone country, then 0.2 percent in the second, and so on.

If the accumulated money from bank fees in a home country in the first year is insufficient to finance the closure of a bank, other funds in euro zone countries would be expected to contribute up to 10 percent of their accumulated money to help.

In the second year, the home fund would only be obliged to use up 90 percent of its accumulated funds to finance the cost of closing down a bank before it could call on its euro zone partners, who would be required to chip in with up to 20 percent of what they hold to help.

The obligation for the home country before it could call on partners would decrease by 10 percent each year and the potential obligation for other euro zone countries would rise by 10 percent.

In this way, by the tenth year, the home country fund would only have to contribute 10 percent of their funds before calling on its euro zone partners, who, like the home country, would be obliged to contribute whatever was required – up to 100 pct of their total funds – to pay for the bank closure.

If the cost of closing down a bank in any of the 10 transition years turns out to be bigger than the combined home country contribution and the proportionate percentage help of other funds, the home country fund could impose an additional levy on its own banking sector.

If that were still insufficient, the government of the country in which the bank is located could provide bridge financing, to be repaid from bank fees later, or if it does not have the cash, it could ask for a program from the euro zone bailout fund ESM, like Spain did in 2012.

All the national funds for closing down banks would be merged into one Single Resolution Fund for the euro zone after 10 years and from that moment the Single Resolution Fund would finance all bank closures, fully mutualizing risk.

Setting up the Single Resolution Fund and the complex risk and cost sharing arrangement over the 10 transition years is to be enshrined in an intergovernmental treaty, which is to be negotiated by euro zone countries by March 1, 2014, the Lithuanian proposal said.

The use of Single Resolution Fund would be decided by the Board of the Single Resolution Authority, made of up representatives of euro zone countries and institutions.

The Board would vote by qualified majority, rather than unanimity, the Lithuanian proposal said.

Source: Reuters  Brussels Newsroom; Editing by Sonya Hepinstall