* Wednesday report is milestone for Vatican after string of scandals
* Vatican expected to pass more than half of "key and core" requirements
* Progress report due in a year (Edits)
By Philip Pullella
VATICAN CITY, July 15 (Reuters) - A European report on the Vatican's efforts to meet international financial transparency standards will recognise progress over the past three years but still give it a failing grade in seven of 16 "key and core" areas, sources familiar with the report say.
The seat of the Catholic Church, long beset by scandals involving its only bank, is trying to win inclusion in a so-called "white list" of countries that take adequate steps to fight money laundering, tax evasion and other financial crimes.
The report, to be published on Wednesday, will not reach a conclusive judgment, but is expected to show that some progress has been made but more must still be achieved over the course of a reform effort expected to take years.
The report is by Moneyval, "The Committee of Experts on the Evaluation of Anti-Money Laundering Measures and the Financing of Terrorism", a monitoring mechanism of the 47-nation Council of Europe that ensures that member states comply with international financial standards.
Moneyval does not maintain a "white list", but supplies information which could eventually be used by other organisations, such as the Financial Action Task Force (FATF), to determine whether the Vatican belongs on a "black" or "grey" list of countries that fail to measure up.
Any such decision is at least a year away, and would depend on a follow-up evaluation of how well the Vatican implements recommendations in Wednesday's report.
Vatican officials say they are determined to do everything necessary to make the white list.
The Vatican has been trying to shed its image as a suspect financial centre since 1982, when Roberto Calvi, an Italian known as "God's Banker" because of his links to the Vatican, was found hanging from London's Blackfriars Bridge.
Italian magistrates are now investigating the Vatican's own bank, officially known as the Institute for Works of Religion (IOR), the head of which was ousted in a dramatic boardroom showdown in May.
The Moneyval evaluation, which the Vatican requested several years ago, grades a country against 49 recommendations, of which 16 are deemed "key and core".
They cover areas such as the criminalisation of money laundering, confiscation of laundered property, performing due diligence on customers and reporting suspicious transactions.
Sources familiar with the unpublished report said the Vatican would be given a passing grade of "compliant" or "largely compliant" in nine of those 16, and failing grades of "partially compliant" or "non-compliant" in the other seven.
Reuters has not seen the report and was not able to obtain specific details about the areas where the Vatican would be found to have fallen short.
One Vatican source said the report would be considered "good news" considering that the Holy See enacted its financial reform legislation less than three years ago.
"Our intention is to be transparent and to become increasingly more so," one Vatican official said.
It is normal for countries to receive partially compliant or non-compliant marks on their first and even subsequent evaluations, accompanied by suggestions on how to improve.
The Vatican sources compared the performance to Italy, which they said had five non-compliant or partially compliant marks on "key and core" recommendations in a 2005 evaluation.
In 2010, the Vatican drafted new financial transparency laws and set up internal regulations to make sure its bank and all other departments that administer the Catholic Church around the world adhered to international standards on money laundering and terrorism financing.
Moneyval inspectors visited the Vatican in 2011 and 2012. The report they will publish on Wednesday will use direct and pointed language in its recommendations on what must be improved, the sources familiar with it said.
The inspectors are expected to issue a follow up report in a year that will evaluate progress on Wednesday's recommendations.
The Vatican, seat of the 1.2 billion-member Roman Catholic Church, is an independent 108-acre city-state surrounded by Rome and ruled by the pope. Because it has less territory than some family farms and no real economy, it is in a unique diplomatic and financial situation.
Its single financial institution, the IOR, has put it at the centre of controversy and scandal for decades. In 2010, Rome magistrates investigating money laundering froze 23 million euros ($33 million) the IOR held in an Italian bank.
The Vatican said at the time that its bank did nothing wrong and was merely transferring its own funds between its own accounts in Italy and Germany. The money was released in June 2011, but the investigation is continuing.
The Vatican says Italian magistrates apply disproportionate attention to it.
Last May, the board of the IOR unanimously passed a no confidence against Ettore Gotti Tedeschi, 67, the bank's Italian president.
Gotti Tedeschi, a conservative Catholic who heads the Italian retail unit of Spain's Banco Santander, said he was being punished for advocating transparency. The Vatican and board members said he was an inefficient and divisive manager.
The IOR's most infamous entanglement with scandal involved the collapse 30 years ago of Banco Ambrosiano, then Italy's largest private bank, whose chairman Calvi's mysterious death in London captured world headlines.
The IOR held a stake in the Ambrosiano, and investigators alleged that it was partly responsible for the fraudulent bankruptcy. The IOR denied any role in the collapse but paid $250 million to creditors in what it called a "goodwill gesture".
The IOR offers financial services to religious orders of priests and nuns, dioceses around the world, Catholic charity groups and Vatican employees. (Reporting By Philip Pullella; Editing by Peter Graff)