The proposal recommends closer coordination between countries and the granting of powers to force losses on the bondholders of failing banks to prevent a repeat of the chaos after the collapse of U.S. bank Lehman Brothers in 2008.

But the legislation is unlikely to take effect before 2015, far too late for Spain, which could be forced to seek a bailout for its banks if it cannot refinance the lenders, which are saddled with bad property loans and other unperforming debt.

"The proposal we have today may be only useful for the future but it does not solve the current problems we face," said Sharon Bowles, chair of the European Parliament's economic and finance committee and one most influential officials in shaping banking regulation in Brussels.

"In the short term we need further measures."

Bowles criticized the delay in announcing the "long overdue" rules, which come almost five years after a collapse in U.S. subprime mortgages started a banking crisis in Europe.

The Commission's draft suggests giving supervisors powers to "bail in" or force losses on bondholders of a bank so that taxpayers are kept off the hook.

The EU executive hopes tighter links between wind-down schemes across the European Union will be the "embryo" for a single resolution fund to close or salvage parts of a flagging bank, although such a fund is some way off.

The law would introduce an insolvency regime for banks in the European Union. It would instruct countries to prepare for a bank collapse, collecting money through an annual levy on banks that would be used to provide emergency loans or guarantees.

If it wins the backing of EU countries and the European parliament, the law would represent a step in the direction of the banking union championed by ECB President Mario Draghi.

Draghi's three-pillar plan for a banking union consists of central monitoring of banks, a fund to wind-down big lenders and a pan-European deposit guarantee. Although this would apply chiefly to the euro zone, it would affect other EU countries.

"Today's proposal is an essential step towards banking union in the EU and will make the banking sector more responsible," said European Commission President Jose Manuel Barroso.

"This will contribute to stability and confidence in the EU in the future, as we work to strengthen and further integrate our interdependent economies."

Michel Barnier, the European Commissioner in charge of regulating finance, said: "We must equip public authorities so that they can deal adequately with future bank crises. Otherwise citizens will once again be left to pay the bill."

HURDLES AHEAD

But there are many hurdles to both achieving Draghi's banking union as well as introducing Barnier's scheme to wind up failed banks.

Britain fiercely resists any attempt by Brussels to impose EU controls over financial services, which account for almost a tenth of its economy. Germany has balked at signing a single European scheme that could see it shoulder the costs of a bank collapse in another country.

Other proposals for a common response to a banking crisis have hit obstacles.

In 2010, the Commission published a framework for deposit guarantee schemes, but EU member states demanded a cut in the size of the funds kept to cover any sudden cash call by savers. That led to an impasse with the European Parliament.

"France, Italy, Britain and Germany were not in favor of creating national funds big enough even to deal with a medium-sized crash," said Peter Simon, a German lawmaker who led negotiations on behalf of the parliament with countries to broker a compromise.

"We suggested that such funds have the equivalent of 1.5 percent of covered deposits and they wanted 0.5 percent," he said. "This kind of protection ... would be fake. It wouldn't even be enough to solve a crisis at a midget bank."

Wednesday's proposal is expected to suggest the creation of national funds, equivalent in size to 1 percent of deposits. That money would cover both the wind-down of a bank and any emergency payout to worried savers.

This would mean that backstop funds in the euro zone should, after 10 years, have gathered roughly 70 billion euros ($87.25 billion) in cash as well as country pledges to pay in, according to estimates by the European Commission.

That figure rises to 100 billion euros for the 27 countries in the European Union. ($1 = 0.8023 euros)

(editing by Elizabeth Piper)

• A Permanent Economic Emergency