Nov. 11 (Bloomberg) -- The European Union may try to wean banks off state aid by increasing the price of the government guarantees they use to issue debt, according to a draft report.

The EU proposed changing the benchmark for the guaranteed debt lines, which are based on an average of the lender’s credit-default swap price between January 2007 and August 2008.

Making banks pay a spread based on the higher credit-swap levels after Lehman Brothers Holdings Inc. failed last year would “entail larger differentiation of pricing” and result in “an increase in prices for banks with problems,” the EU said.

European governments approved $5.3 trillion of aid to banks during the global financial crisis that followed Lehman’s downfall, according to an EU report in June. Governments are now discussing the best ways to withdraw help as conditions improve.

The EU may also start using credit-default swaps as the basis for guarantees on bank debt with a maturity of less than a year. The swaps are derivatives used by lenders to hedge against the risk of default and by investors to speculate on credit quality.

The proposal, dated Nov. 5, comes from an EU panel comprising representatives from the European Commission, the European Central Bank and finance ministries of member states. The report was prepared for the finance ministers’ meetings in Brussels on Nov. 9-10.

Credit-default swaps allow buyers of the contracts to demand payment from the seller should a company fail to adhere to its debt agreements. They pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements. An increase in the contracts signals a deterioration in investor perceptions of credit quality.

To contact the reporters on this story: Ben Moshinsky in Brussels at bmoshinsky@bloomberg.net

Last Updated: November 11, 2009 07:53 EST