On paper, the idea of creating an uber-watchdog with knowledge about the risks in banks' balance sheets and information on how much they depend on central bank funding, appears a perfect recipe for an effective supervisor.

The European Commission is expected to lay out the blueprint in September, giving lawmakers time to discuss changes ahead of an end of year deadline, which must be met before the euro zone's bailout fund can start recapitalizing banks direct.

One German official said it was "totally unrealistic" to expect the new set up to be up and running in six months - some experienced in euro zone politics think it could take 2-3 years - but ECB insiders say they already have a clear outline of their plans and that talks with Brussels have already started.

Much of the detail is still to be decided, but plans as they stand would see the ECB supervise the 25 to 30 large, multi-national commercial euro zone banks such as BNP Paribas (BNPP.PA), Deutsche Bank (DBKGn.DE), Santander (SAN.MC) and UniCredit (CRDI.MI).

"I don't think it's realistic to build the ECB up into a single, unified bank supervisor of all of Europe's thousands of banks ... but we will find a sensible solution in terms of a division of labor," the ECB's Ewald Nowotny said this week.

Smaller banks would remain under national regulator control, while those based in the UK, Sweden and other countries not in the euro will not take part as they have no say in the ECB.

Crucially, the ECB's 23-man decision making body, the Governing Council, would take the key decisions such as on closing a bank, forcing a recapitalization or demanding it merge or shed part of its business.

Aware of the political and reputational sensitivity of the issue, one official involved in the process warned that while it was the right move, the central bank had "nothing to gain but everything to lose" by taking on the new role.

Many central banks were stripped of supervisory powers after problems in the past and the ECB's credibility would be crushed if it gave a bank a clean bill of health only to see it in trouble a few months or years later.

CONFLICT OF INTEREST

The ECB also faces a conflict of interest minefield with the new role, where policymakers' knowledge about a bank or group of banks could influence their monetary policy decisions.

Jens Weidmann, the head of Germany's Bundesbank, said bluntly in a speech on Thursday that conflicts of interest might arise if the ECB took over supervisory tasks and ECB President Mario Draghi has acknowledged the risks as well.

"Any new task in the supervisory area should be rigorously separate from monetary policy tasks," Draghi said on Thursday. "There should be no contamination between the two areas, and we will find ways to make sure this is so."

One idea being bounced around the central bank would be to hold separate meetings for supervision decisions in order to keep some semblance of separation between the roles.

But some economists think it may not be a problem at all. "I'm not sure there is going to be a conflict of interest here," said Marie Diron, a former ECB economist, who now works at Oxford Economics.

"The tools used as a supervisor would be different from its monetary policy tools, the issues are different and the horizons are different. If anything if could be useful as it would give the ECB more information."

More of a short-term problem will be bringing in the right expertise.

To do the extra work, the ECB plans a new department of 25 to 50 top experts at its Frankfurt headquarters who would dovetail with supervisors already in the euro zone's 17 national central banks.

The local specialists would do much of the day-to-day monitoring of banks' health and also remain in charge of less sensitive decisions such as a bank opening a new branch.

It is a 'hub and spoke' model that is already being used in the U.S. where the Federal Reserve oversees heavyweights like J.P Morgan, Citi and Wells Fargo with regional regulators covering the rest.

It is also likely to be a blow for the London-based European Banking Authority (EBA) which, if the ECB gets its way, will be forced into a more back seat role as a supervision standard setter. Even in that area the ECB will gain more influence, upgrading its EBA observer status to full voting member.

QUESTION OF SCOPE

The biggest questions are how many banks the ECB takes charge of, the spectrum of decisions it controls and how much influence current supervisors, such as Germany's BaFin, will retain.

Some, including French central bank Governor Christian Noyer, think it will only work if all banks are put under ECB control - history shows it is often the smaller banks such as Britain's Northern Rock or the Spanish cajas can cause systemic problems.

Others fear it would be too unwieldy and would prefer to keep a larger degree of national influence.

Thomas Huertas, a former senior banking supervisor at Britain's FSA and former vice chairman of EBA, said putting the ECB in charge may not be the magic solution some are hoping for.

"The main problems are currently at the smaller banks, not at the big systemic ones," he said. "It is difficult to see how a proposal that is less than for all the banks in the euro zone would work."

"I don't think Germany will be keen to sign up for a system where an institution such as Bankia in Spain is under a national supervisor and gets European money."

Another crucial detail still to be decided is who will pay to rescue a bank that fails under the new set up. In the U.S. the job is done by the FDIC which is funded by the banking sector and repairs or organizes the burial of a bank that it provides aid to.

But with 17 different countries, the euro zone is far more complex. Politicians know they would be hammered by voters if their taxpayers' money was being used to bailout reckless banks in another corner of the bloc.

The ECB's preference is to have a central euro zone deposit guarantee fund - paid for with proceeds from a bank tax and public money. But again, there is much work to be done.

POWER POLITICS

Banks themselves are giving the new plans a cautious welcome, hopeful that centralized power will create a simpler and more level playing field in Europe.

At the same time they worry confusion may stem from the division of labor between the ECB and national supervisors and are bracing for tougher scrutiny from the body that also provides them with funding and sets monetary policy.

And fearing that orders may be hoisted on them from Frankfurt, some governments may look to preserve power by negotiating concessions in the grey area between what the ECB should be in charge of and what should stay in national hands.

"This is the most important power politics there is," said Guntram Wolff, an economist with Bruegel, a Brussels-based think tank. "If you control the banks, you exercise significant power over sectors of the economy."

"National systems want to keep that authority for themselves. My sense is that stronger countries will not accept giving up their power to a supranational authority. Only countries in financial trouble will do this."

That could potentially render the project lame at birth. Draghi fired a warning shot at politicians on Thursday that he needed full control if the plan was to be effective.

"The leaders have committed substantial political capital to this decision so we expect the proposal will be as strong as the commitment the leaders have made," he said.

(Additional reporting by Huw Jones in London, John O'Donnell in Brussels and Jonathan Gould in Frankfurt, editing by Mike Peacock and Philippa Fletcher)

• A Permanent Economic Emergency