EU agrees on bank capital needs, split over bailout fund

The European Union has agreed that around 100 billion euros is needed to recapitalise the European banking system, but splits remain before a high-profile summit on Sunday over how to strengthen the euro zone's bailout fund.

EU officials told Reuters all 27 member states had agreed that just short of 100 billion euros ($138 billion) was required to bolster bank balance sheets and protect against the threat of a default in Greece or elsewhere, while a banking source said the figure was more than 90 billion.

The figure has been discussed with member states. It is now acceptable for everybody, an EU source involved in the discussions said.

Austria's Finance Minister Maria Fekter said there was discussion about forcing banks to recapitalise, although she said she was not in favor of such a move.

Banks will be required to come up with the capital from shareholders first, and if that fails than national governments will provide the support. Only as a last resort will the European Financial Stability Facility, the region's bailout fund, be used to recapitalise institutions.

A deal on recapitalization clears one hurdle for leaders ahead of the Sunday summit of European leaders, but there remain large areas of disagreement, particularly over how to scale up the EFSF rescue fund to make its lending more effective.

The International Monetary Fund and the EU also do not see eye-to-eye over the sustainability of Greek debts, with the IMF concerned that EU projections may be too optimistic and that deeper debt reduction is needed, EU sources told Reuters.

Despite the differences of opinion, the inspectors are expected to go ahead and approve an 8 billion euro aid payment to Greece next month, the sixth tranche from a 110 billion euro package of EU/IMF loans agreed last May.

Without that payment Greece faces default, possibly dragging the larger economies of Spain and Italy into the mire and sending shockwaves through the European banking system.

In their effort to agree a comprehensive crisis resolution plan, euro zone leaders are striving to agree new steps to reduce Greece's debt, strengthen the capital of banks and leverage the EFSF to stem contagion to bigger economies.

But progress appears to be glacial, particularly when it comes to the EFSF, a 440 billion euro fund set up last year and so far used to bail out Portugal and Ireland.

Sarkozy flew to Frankfurt on Wednesday for emergency talks with German Chancellor Angela Merkel, the head of the IMF and other top euro zone officials. French media reported he missed the birth of his daughter in the process.

France has argued the most effective way of leveraging the EFSF is to turn it into a bank which could use funding from the European Central Bank, but both the ECB and Berlin oppose this and the proposal now appears to be dead.

Instead, there is an initiative to use the EFSF to guarantee a portion of potential losses on new euro zone debt, a way of trying to restore market confidence that Italian and Spanish bonds are safe to buy. By guaranteeing only a portion, perhaps a third or a fifth, of each debt issue, the EFSF's funds would stretch 3-5 times further.

Analysts are concerned that such a plan could create a two-tier bond market, with bonds that have guarantees trading at a premium to the secondary market -- an outcome that would likely fuel the turmoil markets are already in.

Failure to reach a deal on Sunday would further undermine market confidence in the currency bloc and its ability to solve the two-year-long crisis, which threatens the viability of the single currency.

Markets caught up with the downbeat tone from policymakers. European shares fell, having risen this week on hopes of decisive action from euro zone leaders. The euro weakened on reports that the summit could be postponed, then rebounded when the reports were dismissed.

While France has been upbeat about producing a definitive breakthrough on Sunday, Germany and others have counseled caution, saying it will only be another step on a long road to solving the debt crisis.

I don't think they can meet expectations. The summit will fall well, well short of the kind of big bang needed to reassure the markets, said Simon Tilford, chief economist at the Center for European Reform in London.

Guidelines for changes to the bailout fund obtained by Reuters confirmed it will be able to buy bonds on the secondary market once a request from a country is approved by ECB and euro zone finance officials.

A draft statement for Sunday's summit showed euro zone countries will make rules to limit budget deficits and public debt part of national legislation by the end of next year.

But the statement gave no indication of progress on the main areas of dispute -- particularly the leverage issue.

FORCED BANK LOSSES?

Adding to uncertainty, EU officials said there was growing acceptance among key euro zone member states that further private sector involvement in Greek debt reduction may have to be forced, not voluntary -- an outcome ruled out up to now.

Let's be serious, everybody knows that a 50 percent haircut, as Germany is asking for, is not a voluntary move, one EU official said. Leaders will also have to agree on a new bailout package for Greece, one that is expected to be at least 110 billion euros, not including the private sector's role.

In July, private investors agreed to contribute 50 billion euros to reducing Greece's debt via a debt buyback and swap agreement, which equated to a 21 percent writedown. That is now seen as insufficient to make Athens' debts sustainable.

Greece remains mired in recession and its overall debt is forecast to climb to 357 billion euros ($492 billion) this year, or 162 percent of annual economic output -- which few economists believe can be paid back.

While Europe's leaders rush to stop a larger writedown of Greek debt infecting others in the euro zone, ordinary Greeks are raging at the prospect of years more pain as the price of help from international lenders.

Clashes between rival groups of protesters broke out in front of the Greek parliament, interrupting a rally by tens of thousands against a tough new package of austerity measures due to be approved later in the evening.

(Additional reporting by Gernot Heller and Madeline Chambers in Berlin, Andreas Rinke and Luke Baker in Brussels and Michael Shields in Vienna; Writing by Mike Peacock; editing by Janet McBride)