Banking union a priority for Lew in Europe

Europe's economic weakness and financial turmoil affect the U.S. economy, U.S. Treasury Secretary Jack Lew told EU leaders on Monday, stressing the need to boost demand and move ahead with a euro zone banking union.

"Our economy's strength remains sensitive to events beyond our shores and we have an immense stake in Europe's health and stability," Lew told reporters after talks with European Union leaders including European Commission President Jose Manuel Barroso and European Council President Herman Van Rompuy.

"In this context I was particularly interested in our European partners' plans to strengthen sources of demand at a time of rising unemployment," Lew said. EU forecasts indicate the biggest trading partner of the United States will remain in recession for the second year in a row this year.

Lew's visit also comes shortly after messy negotiations between the euro zone, the International Monetary Fund and Cyprus on a bailout for the Mediterranean island, which in the end forced losses on large Cypriot bank depositors.

In his talks with Barroso and Van Rompuy, Lew underscored the importance of the euro zone moving ahead with plans for a banking union which will involve handing over supervision to the European Central Bank and drafting bank resolution laws.

This would allow the 17-nation bloc to handle problems like the resolution of banks in Cyprus more efficiently.

"They discussed the banking union a bit more than other things - the Americans are keen for the process to move forward," one senior EU official said.

The surprise levy on bank deposits above 100,000 euros in Cyprus agreed as part of the country's bailout has dented confidence that Europe will be united in tackling bank problems rather than leaving countries to struggle alone.

"I appreciated the chance to hear about the scope to broaden the framework for oversight and risk-sharing in line with the euro area's large and interconnected banking sector," Lew said.

The euro zone expects to have the single bank supervision in place sometime next year, and a single bank resolution mechanism shortly afterwards.

"If anything, this crisis and recent events in Cyprus have shown the absolute need to anchor, once and for all, a coherent scheme that would allow resolving failing financial institutions in an effective, predictable and consistent manner across the (European) Union," Van Rompuy said after meeting Lew.

But the next step of the banking union, creating a fund to cover the costs of shutting down banks, is seen as far less likely given the reluctance of Germany and other economically strong countries to underpin such a fund.

Without a fund or backstop to tackle problem banks wherever they arise, there is little chance of breaking the "doom loop" that can drag banks and governments down together.

Lew also discussed European support for financial sanctions on Iran and North Korea. The United States has been pushing these restrictions in order to slowdown the two countries' nuclear weapons programs.

Lew next heads to Frankfurt for a meeting with the chief of the ECB, Mario Draghi.

(Reporting by Anna Yukhananov; Editing by Jan Strupczewski and Catherine Evans)