EU seeks system where no bank too big to fail

The European Union's executive arm is working on rules ranging from curbing banker bonuses to setting up super-watchdogs for lenders to guard against a repeat of a global crisis that sapped credit and hobbled industry.

In a draft document obtained by Reuters, it turns its attention to the question of how some banks became "too big to fail," citing the collapse of Lehman Brothers which tipped the financial system deeper into crisis.

"It should always be possible -- politically and economically -- to allow banks to fail, whatever their size," the draft document says.

But it gives few details of how to prevent countries scrambling to protect parts of a collapsed cross-border bank or group on their own turf.

"Ring-fencing local assets may often hinder rather than help resolve a problem in a cross-border group," the document says.

The draft, which could yet be modified, concludes:

* Any system needs to be legally watertight to encourage private investors to participate in a bank rescue

* There should be a system of funding in place to keep a troubled bank operating while it is being reorganised

* Banks should have closer involvement in guarantee schemes for customer deposits