EU competition officials are frowning on the scheme for giving "unfair" preference to British over European banks, and because it may also breach rules against state aid. Legal experts on EU rules say the Bank of England's rescue plan has little chance of survival with EU bureaucrats.

"It seems to me that this is prima facie state aid because this scheme gives banks operating in the United Kingdom an advantage over other European banks operating outside the UK," said Anthony Woolich, head of competition for the London-based LG law firm.

The scheme, devised by Bank of England Gov. Mervyn King, allows banks to swap some of their troubled mortgages at a discount for state-backed treasury bonds. It is aimed at restoring liquidity to the London financial markets by giving the banks the safe and easily sold treasury bonds, in return for the mortgages that they cannot sell in the current troubled markets.

The irony is that the British scheme is similar to one long used by the European Central Bank, custodian of the euro, that lets European banks use their mortgage bonds as collateral to borrow ECB-issued Eurobonds. That policy has not been questioned by EU officials, and the threat of a ban on the Bank of England plan underlines British fears that the EU is determined to sabotage London's dominant role in financial markets in the name of competition.

The Bank of England plan is not restricted to British banks. It is open to all financial institutions that have a franchise to operate in Britain, and since London is Europe's top finance center, most European banks are represented there. But not all of them have exposure to the troubled British mortgage market.

Europe's competition rules have long been one of the strongest weapons of the Brussels bureaucracy in its strategy of creating a single European economy and market. Companies such as Volkswagen have been fined for pricing cars differently in different EU countries. American giants such as Microsoft have been humbled by $3 billion in fines for breach of EU competition rules.

But French and German companies have proved surprisingly capable of skirting such punishment despite commercial moves like blocking of takeovers by foreign firms and preference for their own national champions that appear on the face of it to be blatant examples of state aid and blocked competition.

Spanish electricity firm Iberdrola last month complained to the European Commission that the state-owned Electricite de France had benefited from some $8 billion in disguised state aid in pension subsidies. Iberdrola is fighting off an attempted EDF takeover. The EU has been trying, with limited success, to bring France to book for blocking an Italian attempt to take over French utility Suez.

France has proved adept at side-stepping the rules. In 2004 it got away with offering a $10 billion line of credit to prevent France Telecom from going bankrupt -- on the grounds that the money was never actually drawn. But it did not have to be since the guarantee that the state funds were available allowed France Telecom to raise money privately, which was the purpose of the French ploy.

The French government also blocked the attempt by the Swiss pharmaceutical firm Novartis to buy Aventis, and instead crafted a merger with another French company to create Sanofi-Aventis, now one of the world's Big Pharma companies and a French national champion.

The question now is whether the Bank of England will be able to defy the EU bureaucracy as the French have been able to do. The evidence is mixed. At first, it seemed likely that the EU would block the British government's attempts to rescue the Northern Rock bank, which suffered a dramatic run last fall. In an interim ruling in December, the initial rescue attempts were found to have "complied with the rescue aid provisions of the Community Guidelines on state aid for rescuing and restructuring firms in difficulty." But the condition was that "rescue aid must be temporary and reversible," and the British government's subsequent takeover of the bank is still being reviewed by the EU.

The latest challenge to the Bank of England's rescue strategy will be an important test case. British public opinion is highly critical of the EU bureaucracy, and there is widespread suspicion that the rules are applied unfairly against Britain. A poll of 1,000 British chief executive officers conducted by the Open Europe think tank last September found that more than half (54 percent) said the costs of the extra EU regulations outweighed the benefits of the Single Market. And 52 percent agreed with the statement that "The EU is failing. Britain will be more prosperous and secure if we keep the Pound and take back powers from the EU."

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