FRANKFURT/MILAN, Sept 17 (Reuters) - Savings bank Sparkasse Bad Sachsa, run by 46 staff in a small spa town at the foot of the picturesque Harz mountain range in western Germany, will next year come under the supervision of Europe's central bank and it is worried.
It will be one of the smallest of 6,000 banks policed by the European Central Bank (ECB) under ground-breaking European Union plans for a banking union unveiled last week.
"We fear that the regional approach that we have here - we do not have RoE (return on equity) targets of 20-25 percent but seek to book small profits to keep our business alive - will no longer be accepted," board member Ralf Mueller said.
"Regulators unfamiliar with the regional situation will say: this bank has too small earnings and will put us into a bucket with other lenders, which have real problems."
Bad Sachsa's reservations lay bare the argument between Berlin and Brussels about how far and deep the banking union should stretch.
"Purely in practical terms it seems impossible for the ECB to monitor 6,000 banks appropriately," German Finance Minister Wolfgang Schaeuble said after European Commission President Jose Manuel Barroso unveiled Brussels' plan last week.
But if they cannot find common ground, a central plank in resolving the region's debt crisis will have been pulled away.
"It has to happen," said Chris Wheeler, analyst at Mediobanca in London. "Without banking union you don't get European union ... it's an essential part of monetary and fiscal union."
About 500 miles south, Genoa-based lender Banca Carige , formed more than 500 years ago as a pawnbroker by a Franciscan monk, is under pressure to strengthen its capital to reach the standards laid out for Europe's big banks.
Under the new model it could be told to find cash by the new supervisors in Frankfurt, who will have the clout to police, penalise and even close banks, and will also monitor their liquidity and can demand they hold more capital.
With core capital ratio of just 6.7 percent of assets, Carige falls short of the 9 percent level its bigger rivals have been told they must hold, although it says it will reach that target by year-end thanks to a reorganisation of its structure.
With more than 1,000 branches nationally and holding a fifth of the market in the wealthy northwestern Liguria region, Carige is one of the mid-sized banks that have not been a priority for regulators during the financial crisis but has become stretched as recession has deepened.
It took 7 billion euros of cheap ECB loans to offset higher funding costs and analysts reckon it needs to bolster its capital to comply with tougher global capital rules that are phased in from next year. Its weak capital base has already seen its credit rating cut.
It and other mid-sized banks could prove an early test of how quickly and aggressively the ECB acts in its new role as the policeman of all euro zone banks. Carige said it welcomed the new structure as long as it created more consistency in supervision across the single currency bloc.
"The principle is right. They must be very careful with the implementation to make sure the same rules apply in all the countries, which is not the case today," Carige's director general Ennio La Monica told Reuters.
He said Carige's capital strengthening plan had already received an informal nod by the Bank of Italy, so the bank had nothing to fear from the ECB.
"I am convinced that the Bank of Italy is one of the most stringent regulators, so I am not afraid of European supervision. In Germany or France, for example, the rules on risk-weighted assets are looser," he said.
ECB supervision could herald a new round of mergers among Italy's medium and small lenders as profits are being hit by the recession and euro zone crisis, according to a source close to the Italian regulator, speaking on condition of anonymity.
The plans laid out by European Commission President Jose Manuel Barroso have been praised as the first structural reform of Europe's troubled and fragmented banking system, five years into the financial crisis and almost three years after the euro zone sovereign crisis blew up.
The plans have sparked concern that a single regulator will be in charge of far too many banks.
Germany immediately said the proposals risked overstretching the ECB, reflecting its desire to retain primary oversight for its regional savings and cooperative banks.
Its opposition stems from concern it will foot the bill to prop up lenders in weak countries and, according to some bankers, a reluctance to deal with any lingering problems among its smaller banks.
There are concerns in EU countries outside the euro zone whose banks have operations within the bloc, such as in Finland or Spain, that the ECB's clout could see it overstep its remit.
Barroso has stressed the ECB will not be in day-to-day charge of supervision, which will still lie with national and local regulators.
Nor will it set the rules. The London-based European Banking Authority (EBA) will produce a single supervisory rule book for all banks in the EU's 27 member states and the ECB will police lenders in the 17 euro zone countries.
The structure paves the way to use European backstops to recapitalise banks and aims to break the vicious cycle between struggling banks and heavily indebted governments.
The ECB looks set to focus on the big banks but having nominal supervision means it can intervene in any of them, if it thought regulators in Italy or Germany, for example, were dragging their feet in taking action.
Spain's slow response in resolving Bankia rattled financial markets and was a case in point, and problems among smaller banks in Ireland, Greece, Spain and Cyprus proved the need for a wide reach, bankers said.
Sparkasse Bad Sachsa will be only 130 miles from the ECB's Frankfurt power base, but it is not reassured by the promise that the central bank will only step in extremis.
"Who decides what an extreme situation is - the lender, the region, someone else?" said Mueller, whose bank's balance sheet is just 130 million euros and it has just 5,500 clients. Deutsche Bank, by comparison, has over 2 trillion euros in assets and more than 30 million customers.
"Right now, we are being supervised by Bundesbank officials based in Hanover. They know the region and its structure well. A big German bank that happens to be doing business here could just pull out, if problems occur. We cannot do that, we have to be able to overcome dry spells together with our customers."
"Our regulators until now understand that and are willing to accept it," he said.
With a capital ratio of more than 20 percent Bad Sachsa is unlikely to come under pressure to bolster its balance sheet.
Mueller's bigger concern, shared by many smaller banks, is the expectation that it will be followed by a single deposit scheme, whereby banks across the euro zone would be responsible for guaranteeing savings in all states.
The blueprint also foresees a levy on all euro zone banks to pay for ECB supervision.
"In my eyes a small savings bank like us should not have to participate in saving a large bank that is on the brink of failure after betting large scale on markets," Mueller said. (Additional reporting by Huw Jones and Francesca Landini; Writing by Steve Slater)