Picture: Reuters.

Brussels - Euro zone countries must prepare to shut their failing “zombie” banks and quickly pool the money to do it, the bloc's top regulator said on Tuesday, ahead of a warts-and-all investigation of its still-fragile financial system.

Daniele Nouy's comments, including her plea for countries to form a united front in solving the problem, give an early indication of how the bloc's chief banking supervisor intends to tackle issues that show up in health checks this year.

They may also influence talks between European lawmakers to finalise the second pillar of banking union - the launch of an agency to close bad banks and a fund to help cover the costs.

This would go hand-in-hand with European Central Bank supervision of the sector.

“The banks that have to disappear are ... the zombie banks,” the ECB watchdog chief told lawmakers in the European Parliament, referring to banks that are so laden with bad loans that they are unable to give fresh credit.

“I hope that action needed will be taken and we will not have any more zombie banks,” she said.

Almost seven years since German small-business lender IKB became Europe's first victim of the global financial crisis, the region is still struggling to lift its economy out of the doldrums and banks are taking much of the blame for not lending.

Nouy, formerly a French regulator, warned that countries needed to do more to jointly back a new fund to pay for the closure of zombie banks, in order for the wider scheme of controlling banks to work.

Negotiators from the European Parliament and EU countries are trying to finalise a new regime along those lines this week.

Nouy is now leading a 1,000-strong team sifting through tens of thousands of banks loan, health checks that economists see as the last chance to draw a line under the crisis.

She said countries need to prepare to shut laggard banks and should club together in supporting a fund to pay for closures. “We need solid ... public backstops,” Nouy said.

“Just like a fire brigade needs access to water ... the SRM (Single Resolution Mechanism to cope with failed banks) needs access to a resolution fund.”

This fund is due to be built up to roughly 55 billion euros ($76 billion) over a decade, using levies from banks.

But it has shortcomings as it stands.

It is small and will initially be made up of a patchwork of country funds without the government backing that would allow it top up borrowings more easily and cheaply.

Nouy said barriers between national funds in the scheme should be broken down within five years rather than ten as planned, allowing countries to help each other if they faced a problem bank too big to cope with alone.

She urged governments to back up the fund to allow it borrow, warning that the fund would be “quickly depleted” by bank closures in its early years. - Reuters