EU seeks to break deadlock over bolstering banks

By John O'Donnell and Robin Emmott

With France and Germany deeply divided over how to bolster the rescue fund that underpins the euro zone, leaders have scheduled a string of meetings in the next days to tackle Greece's debt and limit its impact on the banking system.

Euro zone finance ministers made some progress on Friday, agreeing that holders of Greek government bonds would need to take far more than the 21 percent haircut brokered in July.

"We have agreed yesterday that we have to have a significant increase in the banks' contribution," Jean-Claude Juncker, who chairs the euro group of finance ministers, said on Saturday morning.

On Saturday, EU finance ministers -- including those from countries not in the euro zone -- were trying to decide ways to bolster the capital of European banks to cope with any Greek default and wider contagion across the continent.

EU officials say almost 100 billion euros is required to reinforce the region's banking system. Banks that cannot raise money on the markets will have to turn to national governments, and finally to the European Financial Stability Facility (EFSF).

European banks will be required to increase their core tier one capital ratio to 9 percent to help them withstand losses on sovereign debt, officials have said.

However, the European Commission will urge ministers not to announce a plan on bank recapitalization before they have settled other issues, said one EU official.

These issues included the size of losses for holders of Greek bonds and how to boost the firepower of the euro zone's rescue fund, the EFSF.

"You cannot just progress on recapitalizing banks," said the official. "You also need to see progress on those other issues. They are interlinked."

DEEP DIVISIONS

There is also disagreement over how to recapitalize banks, in particular the extent to which taxpayers' money should be used.

"I think we should not use taxpayers' money," Sweden's Finance Minister Anders Borg told reporters on Saturday. "The guarantee system alone cannot solve the problems. We have to restore credibility with capital."

Deep divisions remain between France and Germany over the best way to scale up the EFSF.

German Chancellor Angela Merkel, French President Nicolas Sarkozy and European Council President Herman Van Rompuy and Commission President Jose Manuel Barroso, were due to meet late on Saturday to try to break the deadlock before Sunday's summit of leaders.

France is keen to rely on the EFSF and fears its credit rating could come under threat if the wrong method is chosen to scale up the fund to prevent contagion spreading to Italy and Spain, the euro zone's third and fourth largest economies.

Ratings agency Standard & Poor's said on Friday it was likely to downgrade France and four other states if Europe slips into recession. It was the second agency this week to cast doubt on France's rating after Moody's on Tuesday. [nL3E7LL0LA]

But Bundesbank president Jens Weidmann said in a newspaper interview released on Saturday that repeatedly expanding the euro zone rescue fund won't resolve the euro zone crisis.

"We've had enough short term measures, sticking plasters that just get us through the next few weeks," British finance minister George Osborne told reporters on Saturday. "We need to address the root causes of the problem."

Discussions over the weekend are expected to include ways to make Greece's debt mountain more manageable.

A bleak analysis by the EU and the International Monetary Fund showed on Friday that private holders of Greek debt may need to accept losses of up to 60 percent on their investments.

Austrian Finance Minister Maria Fekter told reporters Italian Treasury official Vittorio Grilli would negotiate heavier debt writedowns with private investors as part of a second Greek aid package.

Greece's finance minister welcomed a decision late on Friday to approve an 8 billion euro loan tranche that Athens needs next month to pay its bills.

"The disbursement of the sixth tranche is an important and productive step," Evangelos Venizelos told reporters on Saturday.

"Greece is not the central problem, now the point is to take more general and more constructive decisions for the euro zone as a whole."

(Additional reporting by Matthew Falloon; Writing by Sebastian Moffett; Editing by Hugh Lawson)