Common supervision of European banks, possibly by the European Central Bank, would help restore confidence and protect the financial system, ECB Governing Council member Panicos Demetriades was quoted on Sunday as saying.

German business newspaper Handelsblatt reported on Friday, citing European Commission sources, that the Commission would next month propose giving the European Central Bank supervision over all of the euro zone's major banks.

Demetriades, who is also governor of the Central Bank of Cyprus, told Cypriot newspaper Kathimerini in an interview the euro zone faced "unprecedented challenges" and such a banking union was expected to foster greater confidence in the bloc.

"Common supervision of banks of the EU, which possibly the ECB will have responsibility over, is expected to offer greater protection of deposits, restore confidence and better protect the financial system from risks," Demetriades was quoted as saying in its Sunday edition, according to an advance copy.

He said the European Commission was expected to disclose a more analytical proposal on September 11.

European Union leaders agreed at the end of June to set up a single banking supervisor in Europe as a pre-condition to letting the euro zone's rescue funds directly inject cash into lenders, without lending to a government first.

It is part of a wider EU effort to stop the banking and euro zone debt crisis feeding each other.

Handelsblatt said the Commission envisaged national authorities supervising day-to-day business and the ECB only intervening where it saw "dangerous risks". Outside the euro zone, national banking supervisors would stay in charge of their banks, the paper reported.

Stefaan de Rynck, spokesman for Michel Barnier, the European commissioner for financial services who is drafting the proposal, said on Friday how the ECB would work with local regulators on the ground was still being fleshed out.

Cyprus was forced to seek a bailout from international lenders in June to help its second-largest bank, which has been badly damaged by exposure to Greece. The country was shut out of international capital markets more than a year ago, forcing it to go to its EU partners for aid.

Demetriades said he hoped a Cypriot financial bailout with the EU, the IMF and the ECB, known collectively as the "troika", could be brokered in September. Once in a bailout mechanism, Cypriot bonds would again be considered eligible as collateral used by banks in ECB refinancing operations, he said.

Cypriot sovereign paper ceased to be eligible in June, and after the world's third international ratings agency, Standard and Poor's, classified its bonds into the "junk" category.

Although Cyprus is primarily seeking aid to buffer banks, its bailout will also cover fiscal requirements.

Cyprus recorded its fourth straight quarter of economic contraction in the second quarter of 2012, bringing its annualised drop in growth to 2.3 percent.

"In my view, fiscal consolidation should be designed in line with measures to enhance growth, simply because without growth, deficits do not fall but, to the contrary - and despite any cuts in spending - could widen," Demetriades said.