A hard-fought EU agreement on how to handle failing banks attracted sharp criticism on Thursday, with the president of the European Parliament describing it as possibly the biggest policy failure since the euro crisis erupted four years ago.

The deal, clinched by European finance ministers in the early morning hours of Thursday after months of difficult negotiations, sets out a blueprint for shuttering troubled lenders, which pushed countries like Ireland and Cyprus to the brink of bankruptcy.

But it falls short of what some nations, including France, Spain and Italy, had sought, by ruling out direct use of funds from Europe's rescue mechanism (ESM) in the near-term, and setting up what could turn out to be a cumbersome decision-making process for winding down banks.

Even countries that signed off on the deal sounded lukewarm about it, with Italian Prime Minister Enrico Letta telling reporters: "This seems to be a step forward."

Martin Schulz, the German president of the European Parliament, which under EU rules must approve the agreement for it to take effect, was scathing in his assessment, vowing to reject the deal in its current form.

"This is comparable to dealing with an emergency admission to hospital by first convening the hospital's board of directors instead of giving the patient immediate treatment," he said in the text of a speech to be given to EU leaders at a summit in Brussels on Thursday.

"If we were to implement the ECOFIN decisions on a banking union in this way, it would not only be a lost opportunity. It would be the biggest mistake yet in the resolution of the crisis," he said, referring to the body of EU finance ministers which cut the deal on Wednesday night.

Guntram Wolff, director of the influential Bruegel think tank, was less critical of how the single resolution body would be run, but described the funding approach as a major disappointment.

"The ESM is clearly out of the game, there will be no direct bank recapitalizations," Wolff told Reuters. "On this front we can say quite clearly that this deal is unsatisfactory and insufficient to break the vicious circle between banks and sovereigns."

GERMAN DEMANDS

In the talks, German Finance Minister Wolfgang Schaeuble refused to budge from his long-standing position that European taxpayer money, in the form of the ESM, not be used as a backstop during the initial phase of so-called "banking union".

Europe has agreed to build up a resolution fund of 55 billion euros ($75 billion) by imposing a levy on banks, but that will take a decade. A crucial question in the talks was who pays during the period when the fund lacks sufficient cash.

Germany insisted that countries themselves be accountable once a bank's creditors and investors have taken a hit, while leaving the door ajar to mutualization of risks over time.

It was also successful in its drive to prevent the European Commission from obtaining sole power to decide on the closure of banks. Instead, national governments will retain a say in such decisions, alongside a new Single Resolution Board (SRB).

At a news conference in Paris with his French counterpart Pierre Moscovici, Schaeuble described the result as "convincing."

Economists at J.P. Morgan also praised elements of the deal, saying those who may have expected large-scale taxpayer funded bank recapitalizations were bound to be disappointed.

"We continue to see the direction of travel more constructively," said Malcolm Barr in a research note.

"Germany has resisted the mutualization of legacy banking exposures ex ante, as always seemed likely to us. But the commitment toward a mutualized structure over time suggests to us that the German position would ease at the margin if market pressures were to be reignited."