* German MEP Langen - supervision turned on its head to please Spain
* Lawmakers warn banking union could cause 'explosive' split
* MEP Giegold - all EU states should be 'lured into' scheme
By John O'Donnell
BRUSSELS, Sept 26 Creation of a banking union to help resolve the euro zone debt crisis could lead to a split within the wider European Union, lawmakers in the European Parliament warned during a debate that laid bare the extent of tensions in the bloc.
Brussels proposed earlier this month that the European Central Bank (ECB) take charge of supervising all banks in the euro currency zone, as a first step towards creating a banking union under which euro zone countries would eventually jointly back their lenders.
However, the plan has sparked concerns among the 10 EU countries which do not use the euro that they will be indirectly affected by the ECB's new supervisory powers and put at a competitive disadvantage, whether they join the scheme or not.
Legally, the European Parliament will have no say in writing much of the legislation for a banking union. But it has powers to amend other important financial regulations and can exert influence to change or even delay the new regime.
"What's the point of having a single supervisory mechanism (for the euro zone) when you have the UK with its 60 percent of the financial market not involved?" said Werner Langen, a German lawmaker, in the debate on Wednesday.
"Instead of a single supervisory mechanism, we have a division of Europe, a very explosive division."
Langen's views were echoed throughout the debate of the parliament's influential economic and monetary affairs committee, where members from around Europe voiced conflicting views about the shape of a banking union.
"What we don't want to do here is split the EU down the middle," said Wolf Klinz, a German member of parliament. "What we don't want to see is that the British push themselves into a corner where they have a referendum and they say ... that's enough for us."
A banking union, which would aim to restore confidence in an industry that has been battered by crisis for nearly five years, has three major steps: the ECB takes over monitoring euro zone banks and others that sign up; a single fund is created to close down and settle the debts of failed banks; and a comprehensive scheme to protect savers' deposits is established.
As well as building the foundation for better control of banks, the union would be important because it should allow the euro zone's rescue fund, the European Stability Mechanism (ESM), to directly inject much-needed capital into banks, such as those in Spain.
"We are under time pressure," said Sven Giegold, a German member of the parliament, who also flagged concerns about a two-tier scheme damaging those countries on the outside. "The banking union ... is linked to access to the ESM."
This pledge, made by euro zone leaders in June, appears to be unravelling, however, after Germany, the Netherlands and Finland drew a distinction between future banking problems and "legacy" difficulties - which could mean that problem banks in Spain and Ireland remain the states' responsibility.
"This proposal is to allow for the direct recapitalisation of Spanish banks because Spain doesn't want to put in a normal application (for aid)," said Langen, who is a member of the CDU, the same political party as German Chancellor Angela Merkel.
"The whole European system of banking supervision is being turned on its head for the sake of Spain. As this thing has been turned on its head, we need to turn it back again," Langen said.
The debate underscored a central problem of the union - that it could drive a wedge between those countries inside the scheme and those outside, whose banks may suffer as a result.
Swedish Finance Minister Anders Borg has said he would not accept ECB oversight of Nordea, the Nordic region's biggest bank, as long as his country remains outside a banking union. Nordea has its headquarters outside the euro zone in Stockholm, but has major operations in Finland, the sole Nordic country to use the common currency.
While Britain will stay outside the scheme, many international banks in London - ranging from HSBC to Citi - have operations in the euro zone that will be affected by the ECB's new supervisory reach.
London is worried that the ECB, emboldened by its new powers, will demand regulation that could undermine the city's position as Europe's financial capital.
Some believe that the European Banking Authority (EBA), set up to coordinate the supervision of banks in response to the financial crisis and which is run by regulators from across the European Union, could act as a counterbalance.
The European Commission has already suggested a special voting mechanism among EU regulators as a counterweight to the power of those in the euro zone.
"Countries should be lured in, tempted in - it should be made difficult for a country to refuse," said Giegold, who will play a leading role in talks about the plan.
"The system should be so attractive that everyone will want to join," Giegold said, in an appeal which is likely to be ignored in London.
The close ties between some troubled governments and the banks they supervise - and on which they also rely to buy their debt - have dragged both ever-deeper into crisis.
A banking union would break this link by making the policing of banks supranational and establishing central schemes paid into collectively to cover the costs of closing failed lenders and protecting savers' deposits.