EU prepares to help banks amid worries on Ireland

By John O'Donnell and Julien Toyer

BRUSSELS (Reuters) - European Union leaders will agree this week to prepare to recapitalize banks that fail upcoming stress tests, according to a draft statement obtained by Reuters on Wednesday.

Thursday's EU leaders' summit is supposed to sign off on a program of better economic governance. But urgent issues such as whether a crisis in Irish banks is worse than believed are likely to dominate discussions on the sidelines.

German Chancellor Angela Merkel will meet Irish Prime Minister Enda Kenny at the summit, with concerns growing that Ireland may need more than the 35 billion euros already set aside under an EU/IMF bailout to prop up its banks.

But with Irish bank stress tests still under way and any preliminary findings under wraps, Kenny is unlikely to be able to sooth such worries.

"There is almost certainly not going to be a resolution of the Irish issues tomorrow or Friday," said one European diplomat, who spoke on condition of anonymity.

"The feeling is that the outstanding issues for Ireland, which is not just the interest rate (on EU-IMF loans) but the banking question, are better dealt with as a package," he added, saying countries may have to meet again to tackle the matter.

In a draft statement due to be published after the March 24/25 summit, the leaders will outline only their broad ambition to agree on a plan to restructure troubled banks and decide how governments can help them.

The announcement will be a direct response to demands from the top EU regulator, the European Banking Authority, for backstops to be in place before it publishes pan-EU stress test results of 90 banks in June.

But the leaders will leave many questions unanswered, including how Ireland could be helped further if its existing bailout loans are not enough.

Ireland is stress testing its banks and will have the results by the end of this month, though it remains unclear how high the hurdles to pass the financial health checks will be.

In the last round of tests, Irish banks were given a clean bill of health -- only months before the EU and International Monetary Fund were called to provide a bailout.

The European Central Bank, which is supporting Irish banks by lending them money they would normally borrow from peers, is watching the situation closely, aware that a deterioration could rattle euro zone investors further.

ECB loans to banks in Ireland hit 117 billion euros last month, more than a third higher than a year ago. The Irish central bank has also more than quadrupled its lending to the country's banks, to 70 billion euros, over the same time.

"A credible solution to the continuing problems in the Irish banking sector is probably the one issue that is very urgent," said Sony Kapoor, of London think tank Re-Define. "The leaders know they have to deliver."

Of the countries facing banking difficulties, only Spain has announced a concrete plan to recapitalize lenders. Others, such as Germany, are under less pressure because the EU's top economic power can more easily afford to clean up bank problems.

Germany and France are also fighting a separate battle to force Ireland to cut its corporate tax rate, but this will not stand in the way of tackling a serious bank crisis that has threatened to spill over to Portugal, Greece and elsewhere.

(Additional reporting by Carmel Crimmins in Dublin; Editing by Dan Grebler)