Oct. 1 (Bloomberg) -- European Union banks will have to hold more capital for asset-backed bonds as part of a regulatory overhaul proposed today in response to the worst financial crisis since the Great Depression.

Charlie McCreevy, EU financial-services commissioner, advanced measures to tighten the oversight of lenders and curb practices such as selling off questionable loans to investors that led to a global credit crunch and record bank losses.

``Capital and strong financial institutions are the lifeblood of an economy,'' McCreevy said in a Bloomberg Television interview in Brussels. ``Therefore, the authorities have to take actions.''

European governments have bailed out four lenders this week and credit markets seized up as U.S. lawmakers struggled to pass a $700 billion bank rescue. The U.S. Congress must approve the package ``for the sake of global finance,'' European Central Bank President Jean-Claude Trichet said late yesterday.

McCreevy's proposal seeks higher capital standards for the securities built out of loans or other assets, referred to as structured finance, at the heart of the market turmoil. Lenders also would get stricter limits on the size of any individual risk they take on, even if from another bank.

The measure also seeks to tighten cooperation among regulators, with each multinational bank overseen by a college of authorities from every country where it does business.

`Additional Concern'

The European Banking Federation said the proposal contains provisions that may restrict banks' ability to lend money to each other.

``The EBF fears that this may well affect adversely the scope and cost of banks credit activities,'' the banking group said in the statement. ``Against the backdrop of a likely economic slowdown in Europe and worldwide, the new large exposures regime constitutes an additional concern.''

The commission's plan, which updates the law enacting the Basel II global standards in the EU, now goes to the European Parliament and the council of EU governments. Both policy-making bodies must agree for the package to become law, which is planned to take effect at the start of 2011.

``Capital-requirement reductions for risk mitigation in the past haven't always reflected reality,'' said Derek Chambers, an analyst at Standard & Poor's Equity Research Ltd. in London. ``Making the capital requirements responsive to risk is right. Not allowing artificial devices to arbitrarily reduce regulatory capital is right. But I'm not sure that altering one little piece of the jigsaw is going to solve everything.''

Structured Finance

European banks have written off $229 billion out of a global total of $588 billion in the rout triggered last year by the collapse of the U.S. subprime mortgage market, according to data compiled by Bloomberg.

Banks will be subject to new requirements to monitor the performance of any structured-finance instruments they invest in, such as the mortgage-backed bonds that spread losses around the world from defaults by U.S. home buyers.

Lenders would have to receive assurances that the organizers of such deals did due diligence on the underlying loans or assets, and intended to retain at least 5 percent ownership.

The rule will force banks to hold capital on 5 percent of the loans they package as securities and sell to investors. Now those loans require no capital once sold off the lenders' books.

No `Single Answer'

McCreevy said that level could be increased if the parliament or national governments request it.

``We in the European Commission can assist in providing some of the solutions,'' McCreevy said. ``There is no one single answer to the financial turmoil.''

France and Belgium yesterday backed a 6.4 billion euro ($9.1 billion) rescue for Dexia SA, a day after Fortis received aid from Belgium, the Netherlands and Luxembourg, and the U.K. government nationalized Bradford & Bingley Plc. Irish authorities said yesterday that they would guarantee bank deposits and debt for two years.

The ECB is trying to revive liquidity by auctioning both euros and dollars to its back system. It today offered to drain 200 billion euros from money markets after being swamped by record deposits from banks and raised the amount of dollars it is offering banks overnight to $50 billion from yesterday's $30 billion.

`Piecemeal Approach'

The Organization for Economic Cooperation and Development said Europe may require a more comprehensive approach to support banks.

``Considering the exposure of European financial institutions, we might have to start thinking of a systemic plan for Europe if things don't improve on the other side of the Atlantic,'' OECD Secretary General Angel Gurria said in Paris. ``The piecemeal approach may not work in Europe either.''

Investors are demanding the highest-ever yield spread to buy the debt of European financial firms rather than bonds of investment-grade companies on concern more banks will collapse as funding dries up.

With the crisis now more than a year long and with few signs it will end soon, French President Nicolas Sarkozy is convening an Oct. 4 meeting in Paris of European representatives from the Group of Eight as well as Trichet. France currently holds the rotating presidency of the European Union.

``We need a more systematic approach to give an answer to the financial crisis we're experiencing,'' said Luxembourg Prime and Finance Minister Jean-Claude Juncker, who will attend the talks as chairman of the panel of finance chiefs from the euro- area.

To contact the reporters on this story: John Rega in Brussels at jrega@bloomberg.netJohn Dawson in London at hepburn@bloomberg.net

Last Updated: October 1, 2008 11:35 EDT