European Commission President Jose Manuel Barroso urged the European Central Bank to do everything in its power to maintain financial stability in the euro zone, saying the EU faced the biggest challenge in its 50-year history.
Delivering his annual "State of the Union" speech to the European Parliament on Wednesday, Barroso set out a range of steps the euro zone needed to get on top of its 20-month debt crisis, including rapid approval of an agreement struck on July 21 to bolster the EFSF bailout fund and help recapitalize banks.
He suggested the Commission was also looking at ways to increase the firepower of the fund, possibly via some form of leverage, seen by markets as vital if it is to offer protection to large states such as Italy and Spain.
In a signal that in the short term the ECB, with its unlimited access to liquidity, may be the only European institution capable of staving off the pressure on weaker euro zone states, Barroso called on the central bank to step up.
"We trust that the European Central Bank -- in full respect of the (EU) treaty -- will do whatever is necessary to ensure the integrity of the euro area and to ensure its financial stability," he said.
A number of ECB policymakers are unhappy at shouldering a burden they believe is one for governments. Germany's Juergen Stark resigned this month, with sources saying his opposition to the ECB's decision to reactivate its bond-buying program to protect Italy and Spain was the reason for leaving.
At the same time, the euro zone's 17 member states must sign off on the July 21 deal, which will make the EFSF more flexible and nimble, and accelerate the introduction of the permanent crisis resolution mechanism, the ESM, Barroso said.
The ESM is scheduled to come into force in July 2013 but Germany and others are keen to bring forward its introduction, possibly by one year.
"The EFSF must immediately be made both stronger and more flexible ... Only then will it be able to deploy precautionary intervention, intervene to support the recapitalization of banks, and intervene in the secondary markets to help avoid contagion," he said.
"Once the EFSF is ratified, we should make the most efficient use of its financial envelope. The Commission is working on options to this end."
Some policymakers have proposed the 440 billion euros in the EFSF could be used as collateral for borrowing, making more money available for crisis fighting. It could also be used to guarantee a first portion of losses on sovereign debt, say 20 percent, which would allow it to be scaled up five times.
But there is no sign yet of agreement on such measures.
In another hint at possible extra support to the European banking system, Barroso said the Commission was considering a wider guarantee mechanism to help banks lend again to the real economy, but he did not elaborate.
German Bund futures, seen as a safe haven from the crisis, fell from a session high after the speech, partly in reaction to hint of wider banking system support. The euro traded marginally stronger at 1.3609 to the dollar.
CRISIS OF A LIFETIME
Barroso called the region's crisis, which has spread from Greece to Ireland and Portugal and now threatens Spain, Italy and the global economy, a crisis of confidence that had infected finance, economics and society.
"We are confronted by the greatest challenge the European Union has seen in its history," he said flatly, a statement that would suggest the region's problems are the worst since the European Economic Community came together in 1958.
The European Parliament is among the biggest proponents of euro area bonds -- sovereign debt jointly underwritten by all 17 euro zone members -- as a way of tackling the crisis. But Germany and others are steadfastly opposed.
The European Commission has promised to present proposals for such bonds in the coming weeks, and Barroso underlined that intention, but he nuanced it on Wednesday, saying the bonds should be called "stability bonds" rather than "euro bonds."
He also said they should only be considered only once there was deeper economic integration among the region's states.
"Once the euro area is fully equipped with the instruments necessary to ensure both integration and discipline, the issuance of joint debt will be seen as a natural and advantageous step for all," he said.
"On condition that such euro bonds will be 'stability bonds': bonds that are designed in a way that rewards those who play by the rules, and deters those who don't."
In other initiatives put forward in the speech, which Barroso has adopted as a way of weighing up the direction of the EU in much the same way the U.S. president does in his State of the Union address to Congress, the Commission president advocated tighter financial regulation.
There are already measures to impose tighter controls on derivatives trading, naked short-selling and bankers' pay. Barroso said proposals would be delivered by the end of the year to crack down on ratings agencies, and said work was continuing on a tax on financial transactions.
"In the last three years, member states have granted aid and provided guarantees of 4.6 trillion euros to the financial sector. It is time for the financial sector to make a contribution back to society," he said, adding that such a tax could raise as much as 55 billion euros a year.
Such a tax is strongly opposed by the United States and Britain, which has the EU's largest financial center.
"Any financial transaction tax would have to apply globally and there are a number of practical issues that need to be worked through," a Treasury spokesman said.
Barroso also indicated that the European Investment Bank, which is underwritten by the EU's 27 member states, could be better deployed to stimulate economic growth, possibly by activating more of its callable capital.
"We need to explore ways to reinforce the EIB's resources and capital base so that it can lend to the real economy," he said, adding that the bank could do "much more" to finance long-term investment.
And he promised that the Commission would in the coming weeks present a proposal for a "single, coherent" way of deepening economic coordination in Europe, building on new, tighter budgetary rules known as the 'six pack', which were approved by the parliament on Wednesday after months of delay.
(Writing by Luke Baker; Editing by Rex Merrifield/Mike Peacock)