David Cameron "must go into battle" in Brussels to protect the UK from a European banking union that could have "momentous" consequences, a parliamentary committee has warned.
Although reforms are needed to restore credibility and stability to euro area banks there is a "significant risk" new measures will undermine the single market and leave Britain marginalised, peers said.
In a report, the House of Lords EU Committee warned the Government its assurances about the impact changes will have on the City of London "may prove misplaced" and also pushed for wider protection of the UK's trade interests.
George Osborne will discuss plans for a banking union at a meeting with European finance ministers in Brussels on Wednesday but talks on the complex reforms will continue into a meeting of EU premiers on Thursday.
The European Council summit will attempt to thrash out an agreement on the first steps of a new system, including key plans for a Single Supervisory Mechanism (SSM), which would introduce central monitoring of banks.
Peers urged the Chancellor and Prime Minister to do "all in their power" to ensure London remains Europe's top financial market as well as protecting the integrity of the single market.
But they warned the Prime Minister that, despite Britain's refusal to join up to a banking union, it would be "disastrous" if the Government became isolated in key negotiations.
Lord Harrison, chairman of the House of Lords EU sub-committee on Economic and Financial Affairs, said: "Tomorrow the Government must go into battle at the critical European Summit to fight for the City of London to retain its premier position as the centre of EU financial services.
"It is vital the UK Government get the negotiations right so that the banking union does not undermine the single market as a whole and the single market in financial service in particular, which is so vital to the UK and the City of London. And it must not threaten the position of the UK and other countries who choose to remain outside of the European banking union.
"The Commission's original proposals failed to meet these concerns, so the Government must urgently secure a deal that is right for the City and right for the single market."