The UK Government has written to the European Commission to set out its views on proposals for tighter regulation of Europe's banks, reports The Telegraph.
The Treasury document seen by The Telegraph recommends that any proposed regulation of EU banks should include smaller institutions, including the German Landesbanks.
The Germans are known to oppose any move to regulate smaller banks, believing that they pose little threat to wider European financial stability. It is thought that the difference in opinion could bring the two powerful EU nations to loggerheads.
Greater EU financial regulation is billed as the key to solving the European financial crisis, which has at times threatened to derail the Euro and with it the entire global economy.
The German chancellor believes that any new EU laws to regulate financial institutions should focus on 'big banks'.
"It's not about supervising every bank and in any case the ECB can't do that. Rather, it's about the quality of the supervision, not just about the quantity," she said recently.
The UK is thought to favour more far-reaching legislation, believing that instability in a large number of smaller banks could still cause significant problems.
"There is ample precedent that it is not only the largest banks that may cause systemic instability," read the British document.
"Small and medium-sized banks may in aggregate pose significant risks to Euro area financial stability, and medium-sized institutions may do so individually in times of stress," it continued.
Although UK banks are outside of proposed greater regulation, experts believe that any laws passed in Brussels will affect the UK financial sector considerably. Paul Edmonson works for law firm CMS Cameron McKenna.
"UK-based banks will not escape the new ECB supervisory regime, in that the ECB will be the host supervisor for their branches and cross-border services in Eurozone countries" he told The Telegraph.