European leaders must put the funds and tools in place to rescue ailing lenders before they transfer oversight to the region’s central bank, or they risk worsening the sovereign debt crisis, Central Bank of Ireland deputy governor Matthew Elderfield has said.

Policymakers need to ensure rules for capital injections and the orderly winding down of failed lenders are “fully operational” by the time the European Central Bank takes charge under plans for banking union, he said in a speech in London yesterday.

Without the right structures, governments may be forced to inject additional capital into banks, putting more pressure on budget deficits, he said.

“It is a distinctly unpleasant situation to be asked to put out a fire and to find your fire extinguisher is half-full and that the only way to get a reload is to increase debt and austerity,” Mr Elderfield said.

European Union leaders, trying to stop the cost of failing lenders driving up the price of borrowing for governments, aim to hammer out details of the agreement by January, when the ECB is set to take over supervision of the euro zone’s lenders.

A common supervisor would open the door for the euro area’s firewall fund to offer direct aid to banks, spreading the cost of bailing out lenders across states.

The voting structure governance of the European Banking Authority, which co-ordinates financial rule-making across all 27 EU nations, needs to be altered to address the concerns of countries such as the UK that are outside the euro zone, Mr Elderfield said. – Bloomberg