The European Union's executive office on Wednesday said the 17-country eurozone needs a "banking union" that can centrally oversee and _ if needed _ bail out the sector, which has become a weak link in the continent's financial system.
Fears that the cost of bank rescues could cause governments to need bailouts of their own have been fueling Europe's debt crisis in recent months.
Spain is in a particularly bad situation because its banks are not only holding massive amounts of shaky government bonds but also sitting on huge losses on real estate investments. The country's borrowing rates have hit record highs this week as investors worry it does not have the money to save its banks. One of them asked for (EURO)19 billion ($23.6 billion) last week.
But Europe's attempts to address the weakness of some countries' banking sectors has been hindered by the lack of a central authority with the power to tell banks what to do to improve their balance sheets. That power remains in the hands of the dozens of national regulators.
Highlighting the urgency of the issue, the European Commission suggested Wednesday that regulation of the entire eurozone banking sector be done centrally and that the cost of bailouts be shared.
`'Ambitious steps to accelerate and deepen financial integration may be needed. Already before the crisis, it was acknowledged that the EU model of cross-border banking was not stable," the Commission said in a report on how to deal with the financial crisis which has pushed the shared single currency to the brink of breakup.
Part of the proposal would see the eurozone's permament bailout fund, the ESM, charged with helping pay for bank bailouts. That would protect individual governments from having their public finances overwhelmed by the cost of rescuing a bank.
"Direct recapitalization by the ESM might be envisaged," the Commission's report said.
EU Commission President Jose Manuel Barroso said the ESM should be better able to help out troubled banks across national borders if need be. In the future, `'the building blocks could include a banking union with integrated financial supervision and a single deposit guarantee scheme," he said.
Germany, however, has long been against such an arrangement because, as the currency bloc's paymaster, it would fund the lion's share of any expenses the European bailout fund runs into. German Chancellor Angela Merkel's spokesman, Steffen Seibert, said there was no change in the country's views: "The German position on direct recapitalization of banks from the European rescue fund is known."
EU Commissioner Olli Rehn cautioned that the plan might call for the reopening of an EU treaty, a politically risky affair in the best of circumstances.
The European Commission also made specific recommendations to nations mired in the financial crisis on how to manage its national budgets and rein in debt and spending.
Spain, which is currently the focus of the European financial crisis, should be given an extra year _ to 2014 _ to get its budget deficit back within European targets.
Rehn said the Spanish government should be given such an extension only if it can effectively control the excessive spending in the semi-autonomous regions and present `'solid two year budget plans for 2013 and 2014."
In this case, `'we are ready to consider proposing an extension of the deadline to correct the excessive deficit by one year," Rehn said.
Spanish financial markets improved briefly on the news, with the government's 10-year bond yield edging down. The respite proved short-lived as investors focused on the longer-term challenges facing Spain, which is in its second recession in three year, suffers unemployment of near 25 percent and has not yet made clear where it will find money to fund its latest bank rescue, of lender Bankia.
The commission also recommended that Spain "accelerate the increase in the statutory retirement age," and take steps to reintegrate elderly people in the job market. The commission said Spain should tax labor less and rely more on environmental and consumer spending taxes.
In France, as in many other countries, the Commission recommended the country "adopt labor market measures to ensure that older workers stay in employment longer" as well as take steps to make young people more employable.
The commission recommended that Ireland correct its excessive deficit this year, and take further action to address youth unemployment. It also said Ireland needs to pursue the fight against tax evasion, and simplify the regulatory framework for businesses.
European leaders will consider the Commission's recommendations before making a ruling at a summit in June.
Geir Moulson in Berlin and Don Melvin in Brussels contributed to this report.