Merkel says Europe ready to act as big downgrade hits Spain

European Council President Herman Van Rompuy, who chairs EU summits, said he would only present "building blocks" on closer euro zone fiscal and banking union this month and aimed to have detailed proposals in October. Speaking to think tanks in Brussels, he said the euro zone was fighting for survival.

"The rest of the world is looking at us. They are not asking for new debates, they are asking for decisions," he said.

RIFT WITH BRITAIN

As the EU's biggest economy and largest contributor, Germany holds the key to how the bloc comes to Spain's rescue, and whether Europe is able to agree on a banking union with a joint deposit guarantee and a bank resolution fund, as envisaged by the European Central Bank and the European Commission.

Merkel's remarks underscored a growing rift with non-euro member Britain, a longstanding brake on European integration, which said bluntly on Thursday that it would not take any part in a euro zone banking union.

Chancellor of the Exchequer (finance minister) George Osborne told BBC radio: "There is no way that Britain is going to be part of any euro zone banking union.

"I think Britain will require certain safeguards if there is a full-blown banking union."

His comments, reiterated more softly by Cameron in Berlin, highlight the potential complexity of EU negotiations on the issue, since London is the euro zone's main financial centre and could veto deeper banking integration.

Osborne urged the euro zone to use its bailout fund to recapitalise Spain's troubled banks, which are reeling from the bursting of a property bubble and aggravated by recession.

The IMF report goes before the global lender's board on Friday, raising expectations that EU and Spanish officials may have the outlines of a possible rescue plan worked out for when the numbers are released.

One senior EU official indicated that Spain could take a "minimalist" approach to recapitalisation, requiring 30-40 billion euros for four or five weaker institutions, or else a "maximalist" line which might need as much as 100 billion.

"Politicians tend to prefer doing the least that's required, so in the case of Spain, it seems likely that a minimalist approach will be taken," the official said.

Spain has so far made no application for European aid, and officials say it is determined to avoid the kind of humiliating policy conditions and intrusive quarterly EU/IMF inspections imposed on Greece, Ireland and Portugal.

While a rescue loan may be presented for political reasons as going to Spain's FROB bank resolution fund, legally European bodies can lend only to the state, EU officials say. That raises the question of what policy conditions and monitoring would be attached to any assistance.

Under the rules of the EFSF, so far used to bail out Ireland and Portugal, countries can receive aid for their banks without having to submit to the same strict 'conditionality' as under a full bailout programme.

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