European shares fell on Wednesday after the large take up by banks for cheap European Central Bank loans worried investors about the banks' funding needs and eroded hopes they would use the money to buy the region's peripheral debt.

Demand for the ECB tender was way above the 310 billion euros ($404.47 billion) expected by traders polled by Reuters, with traders saying it emphasized the pressure banks are under, making it unlikely they would use it to buy more of the region's risky debt.

The take up rate was higher than expected and it is not good if the banking sector requires that amount of funding, said Angus Campbell, head of sales, Capital Spreads. It raises serious questions about the stability of the banking sector.

The problem is there is a major risk with banks buying the region's peripheral debt. If the economies in Spain and Italy's can not grow next year, all of a sudden European banks are in a bigger hole than they were before.

Banks, which initially rallied after the ECB tender as traders said the cheap money would help ease stretched balance sheets, turned negative on worries about the large take-up rate.

The STOXX Europe 600 Banks index <.SX7P>, which was one of the top performers after the ECB tender, ended down 0.7 percent, reversing all of the session gains.

Adding to the worries about the euro zone debt crisis was a rise in Spanish and Italian government bond yields, highlighting the fact countries still need to get their balance sheets in order and the region's problems had not gone away.

Does it solve all the problems? clearly not. Italy and Spain still have serious deficits, David Coombs, fund manager at Rathbone Brothers, which has $23.85 billion under management, said.

The tender may take the strain off the banking system, but what we still need is for yields in the sovereign euro zone peripheral to come down. We remain underweight (on) equity financials.

The pan-European FTSEurofirst 300 <.FTEU3> index of top shares closed down 0.5 percent at 971.68 points after being up as much as 989.66, with volume thin at 87.1 percent of its 90-day daily average.

The euro zone's blue chip Euro STOXX 50 <.STOXX50E> index closed down 0.8 percent at 2,244.35 points holding just above a key support level - its 50 percent Fibonacci Retracement from its November to December rally at 2,234.07 points.

The index had earlier broken through its 38.2 percent Fibonacci Retracement support level at 2,273.79 percent and now this would act as a resistance level.


Weak company earnings served as a reminder some corporates were facing a weaker growth outlook, technology stocks were the biggest fallers on the index after U.S. software major Oracle's results missed expectations.

Sellers came for Germany's SAP , a rival of Oracle, down 6.1 percent making it the worst performing stock in Europe.

(Reporting by Joanne Frearson; Editing by Jon Loades-Carter)