By Luke Baker and John O'Donnell
BRUSSELS (Reuters) - European Union leaders will examine a detailed plan for completing a banking union and strengthening euro zone fiscal policy next week, with officials concerned that momentum is waning in tackling the debt crisis.
In a report prepared for a December 13-14 EU summit, policymakers have set out a three-step process they hope will strengthen economic and monetary union and help prevent a repeat of the problems that have threatened the survival of the euro.
The 15-page report, overseen by Herman Van Rompuy, the president of the European Council and the chair of EU summits, is the culmination of six months of drafting and responds to a request made by heads of state and government in June.
The paper, put together with the European Commission, the European Central Bank and euro zone finance ministers, lays out the steps required to complete a banking union and proposes creating a stand-alone budget, financed by euro zone countries, that would be used to handle one-off shocks to their economies.
"A more resilient and integrated economic and monetary union would buffer euro area countries against external economic shocks," said the report, unveiled on Thursday.
"The urgency to act stems from the magnitude of the internal and external challenges currently faced by the euro area and its individual members."
Efforts to establish a banking union -- a three-part process which involves creating a single supervisor for all the euro zone's banks, establishing a fund to wind down problem banks and fully coordinating national schemes that guarantee deposits -- are underway but there are already hiccups.
The first step -- the single supervisory mechanism under the European Central Bank -- was due to be completed by the end of the year, but EU finance ministers cannot agree how the mechanism should be structured and how much power the ECB should have, particularly if it conflict with its monetary policy aims.
They are due to meet again on December 12, the day before the summit, to try to reach agreement before EU leaders gather, although it appears unlikely that they will reach a definitive deal until early 2013, partly because of German concerns.
Once the legalities are worked out, the ECB is expected to steadily take over responsibility for overseeing all 6,000 euro zone banks, although it will take up to a year before that process is complete. In his report, Van Rompuy said full ECB oversight should be in place by January 1, 2014.
At that point, it should also be possible for struggling euro zone banks to be directly recapitalised by the region's rescue fund, the European Stability Mechanism, a 500 billion euro facility that started operating in October.
And by then, euro zone countries should also have agreed how to coordinate their national schemes for winding up problem banks and their national deposit schemes, according to the intricate framework set out in the report.
"The top, top priority is to complete the banking union," said a senior EU official who helped draft the report.
"It's basically a downpayment for the rest of the integration process. We have to get banking union right."
Beyond banking union the Van Rompuy report, like an earlier blueprint from European Commission President Jose Manuel Barroso, gets much more ambitious and into difficult territory in which member states may be concerned about sovereignty.
It proposes the establishment of a fund that would provide "financial incentives" to member states as long as they are meeting their economic targets and other agreed goals.
Some have likened the idea to a "candy machine" that would dispense sweets to "well-behaved" countries. Eventually the fund would grow into a stand-alone resources, financed by euro zone countries, that would be used to provide assistance to any member state that suffers an external or one-off shock.
Germany and France have differing visions of how the stand-alone "fiscal capacity" should function and the issue is likely to be debated intensely at the summit, even if any such fund is not expected to be in place until after the end of 2014.
Van Rompuy's report suggests it could be the basis for jointly issued euro zone debt at some point in the future, an issue highly sensitive to Germany, which is concerned that it will end up underwriting other countries excesses.
"In a longer term perspective, a key aspect of a future fiscal capacity, which would need to be examined carefully, would be its possible ability to borrow," the report says.
"A euro area fiscal capacity could indeed offer an appropriate basis for common debt issuance without resorting to the mutualisation of sovereign debt."
The report even raises the possibility of the euro zone establishing its own treasury, hinting at coordinated tax policies across the currency bloc, another sensitive issue of sovereignty that is likely to provoke sharp debate.
Officials underlined that the report was not a prescription for the future, but a basis for discussion, and acknowledged that some ideas were unlikely to survive.
"It tries to strike a balance between what is feasible and what is desirable," the senior official who worked on the report said. "But there are parts where perhaps it veers more towards what is desirable rather than what is really feasible." (Reporting By Luke Baker and John O'Donnell. Editing by Jeremy Gaunt.)