In a proposal that represents one the most significant surrenders of national sovereignty since the creation of the euro in 1999, the European Commission, the EU's executive arm, proposed Wednesday to make the European Central Bank the single supervisor for all 6,000 banks in the 17 countries that use the currency.
Jose Manuel Barroso, the Commission's president, warned that giving up control of banks would be just the start and that countries would have to get used to handing over powers to Europe in order to solve the region's debt problems.
"We cannot continue trying to solve European problems just with national solutions," he said in his annual State of the Union address to Parliament in Strasbourg, France.
"A deep and genuine economic and monetary union ... means ultimately that the present European Union must evolve," he added. "And let's not be afraid of the words. We will need to move toward a federation of nation states."
Barroso's remarks go to the heart of the debate about the survival of the eurozone — whether countries can continue to share a common currency without a unified political system.
As part of forging a tighter EU, many observers and politicians have called for a "banking union" — a unified playbook for all the region's banks. The creation of a single bank supervisor is an important part of this plan.
Other measures being debated include: a European-wide system of depositors' insurance; a single method for winding down bankrupt banks; and allowing the European bailout fund to directly help banks in trouble, instead of lending money only to governments.
In its proposal, the Commission called for the European Central Bank to take over supervisory roles from the member countries' national banking regulators. Currently, the ECB is only in charge of monetary policy for eurozone countries — setting interest rates and printing money.
The plan would also give the ECB the ability to issue and revoke banking licenses, approve large mergers and acquisitions, investigate banks and fine institutions that break the rules.
The Commission hopes its proposal will take effect Jan. 1, 2013, first handing ECB power over the eurozone's bigger banks and eventually adding the rest of the 17-country bloc's lenders a year later.
Europe's banks are at the heart of the region's financial crisis. The government bonds that the banks bought up during the eurozone's boom times are no longer considered safe bets, and the banks are struggling to unload them — usually at hefty losses. On top of this, banks have also had to contend with real estate loans that have turned toxic following the collapse of real estate markets in some countries.
Across the eurozone, governments have had to step in and prop up the banking sector. But rescuing banks is expensive and has added to investor concerns that European countries' debt loads are becoming increasingly unsustainable.
Many banks have also drastically cut back their business: lending to fewer companies and households and ditching investments in other eurozone countries — especially in Greece, Italy and Spain. As well as freezing up the eurozone's economy, this retrenchment has undermined one of the primary purposes of the single currency — to allow money to flow freely and cheaply across national borders.
The Commission's proposal, published Wednesday morning, still needs to be approved by the European Parliament and the Council, on which the heads of state or government of all 27 countries of the European Union sit.
It could be a tough fight since Germany, one of the eurozone's most powerful members, has said it wants the ECB to supervise only those banks which, if they were to go bankrupt, would cause major damage to the eurozone.
German Finance Minister Wolfgang Schaeuble has argued that ECB cannot be an effective supervisor if it has to supervise all 6,000 eurozone banks, many of which only do business in their home countries.
But a European Union official warned that a slimmed-down supervisory system would be irresponsible.
"What the crisis has taught us is that even medium or small banks can create lots of damage," said the official, who would speak only on condition of anonymity to describe how the proposal was put together.
"So it would be irresponsible to devise a system that basically says we're going to focus our attention on the large ones and the small ones: just, you know, don't think about them," she said.
Germany has also balked at the Commission's implementation timeframe, calling it unrealistic, although the French have pushed for a quick start.
In a statement issued Wednesday, the ECB said it welcomed the Commission's proposal.
The plans could heap even more responsibility on the central bank. There is a provision allowing any of the 10 countries in the European Union that don't use the euro to sign up to the supervisory system as well.
In his speech Wednesday, Barroso also warned that the financial crisis is "fueling populism and extremism" in Europe.
"Europe needs a new direction," he said.
Don Melvin in Brussels contributed to this report. Melvin can be reached at http://twitter.com/Don_Melvin . DiLorenzo can be reached at http://twitter.com/sdilorenzo .Suggest a correction