By Staff reporter

Britain could be on a collision course with Berlin over the supervision of smaller banks in the eurozone.

The UK government want the European Central Bank's (ECB) new supervisory powers in the proposed eurozone banking union to oversee all 6,000 banks but Germany wanted just the larger banks to be overseen by the authority.

On Wednesday, the German chancellor Angela Merkel said: "It's not about supervising every bank, and in any case the ECB can't do that. Rather, it's about the quality of the supervision, not just about the quantity."

However, a British negotiating paper seen by the Daily Telegraph said that although it will not join a bank union but backs the broadest plan for the sake of achieving stability

The paper said: “Seeking to limit the banking union merely to the largest banks, or cross-border banks could lead to gaming behaviour and other distortions.”

It added: “There is also ample precedent to suggest that it is not only the largest banks that may cause systemic instability. The examples of the Spanish Cajas and German Landesbanks illustrate the fact that small and medium-sized banks may in aggregate pose significant risks to euro area financial stability, and medium-sized institutions may do so individually in times of stress.”

In the paper, the Treasury also listed a series of demands it wants to be included in the banking union’s legal framework in order to protect Britain’s financial services industry.

“The eurozone banking union must not undermine the single market,” the paper said. “The principles of non-discrimination, freedom of establishment and free movement of capital within the EU should be firmly entrenched in the founding legal instruments, as well as an unambiguous objective to support the single market.”

It added: “State aid rules must be respected. And the design of the banking union should clearly tackle the implicit guarantee for banks, which is a major distortion to the single market.”

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