By John O'Donnell and Matthias Sobolewski
BRUSSELS/BERLIN (Reuters) - The European Commission is to outline within a week how states should recapitalize their banks, but a row between France and Germany over who should foot the bill threatens the pan-EU boost for lenders that investors hope for.
The pending proposal, which an EU source said would be announced in time for a summit of leaders on October 17, had raised high hopes of a grand European plan to prop up weak lenders, driving up stock markets and lifting the euro.
But a German source cautioned on Friday that Berlin and Paris disagree on who should pay to bolster banks, a dispute that could derail any attempt by the EU's executive to coordinate help for banks across the 27-state bloc.
The stakes are high, with European banks expected to need up to 200 billion euros ($270 billion) to cope with the threat of sovereign default.
"If you mark-to-market and allow complete defaults, then you get to these 180-200 billion euros," said one euro zone supervisory source.
Germany, which could easily bankroll its weak lenders, wants countries to stand by their banks. But France, whose banks are heavily exposed to Greek debt and grappling with an interbank lending freeze, fears it could lose its high credit rating by bailing them out.
Rather than a politically embarrassing taxpayer bailout, France would rather shunt the bill onto a euro zone fund, which will soon be able to lend money to governments to help banks. Germany is insisting this should be only a very last resort.
One proposal backed by Paris but opposed by Berlin is for many countries in the euro zone to ask the EFSF for money which would then be used to bolster national bank support schemes.
"One idea considered is to have member states of the euro zone accessing the EFSF together," said a euro zone official. "The money would still be used nationally, but there would not be any stigma for specific countries."
But the German source said Berlin was opposed to France's wish to use the European Financial Stability Facility (EFSF) bailout scheme to recapitalize its own banks.
"The French have misunderstood the EFSF," he said. "Our position is that banks should seek money in the markets first, then come national backstops, and only when there is no money available would it kick in at the European level."
Another EU official said it would not make sense for France to tap the EFSF as this would be more expensive than turning to money markets. "It's not worth the stigma," he said.
A French finance ministry official played down any apparent differences with Germany, saying they both agreed banks needed more capital.
German Chancellor Angela Merkel and French President Nicolas Sarkozy are due to meet in Berlin on Sunday to discuss the euro zone crisis, with bank recapitalization expected to be a central theme of their talks.
The proposal from the European Commission is expected to come in the days following the meeting, sources said.
EU Economic and Monetary Affairs Commissioner Olli Rehn said on Friday he was confident European leaders would be able to decide this month how to recapitalize banks and fight a debt crisis he called the biggest challenge in the history of the monetary union.
"I'm confident that at least all the triple-A countries and most EU member countries can (recapitalize banks) either via markets or by their own funds," he said in Helsinki.
But if that action fails, he said, the EFSF can be used.
"The EFSF facility has been reformed so that in principle it can be used in this, but that is, let's say, an ultimate solution," he said.
An EU source said earlier that the European Commission intended to present member with states a plan that would likely outline how countries could use their own cash and the EFSF to help struggling banks.
"If it is presented before the European Council (leaders' summit on October 17), a decision could follow quickly."
France's top banks - BNP Paribas, Societe Generale and Credit Agricole -- have seen their stock price roughly halve since the start of the year. Franco-Belgian bank Dexia faces possible break-up and may need to be propped up with extra state cash.
($1 = 0.746 Euros)
(Reporting by John O'Donnell, Julien Toyer and Jan Strupczewski in Brussels, Matthias Sobolewski and Philipp Halstrick in Berlin, Mike Shields in Vienna and Jussi Rosendahl in Helsinki; editing by Rex Merrifield/Ruth Pitchford)