European Union paymaster Germany said on Tuesday it was willing to give the European Central Bank more capital if needed to help fight a sovereign debt crisis that continues to shake the euro zone.

ECB sources told Reuters on Monday that the central bank was considering requesting a capital increase from euro zone states to cover the risk of losses on government bonds it has bought to support the 16-nation single currency area.

A Berlin government official, briefing reporters ahead of an EU summit on Thursday and Friday, said ECB President Jean-Claude Trichet might raise the matter at a dinner with EU leaders.

The government supports the ECB in all that it deems important ... If such a request comes, we will judge it positively, said the official, speaking on condition of anonymity. He said the ECB had not yet made a formal request.

The German official said a bigger ECB capital base would show financial markets that the central bank had enough capital to buy new government bonds if needed.

One euro zone central bank source said the ECB was eyeing a doubling of its subscribed capital of almost 5.8 billion euros, which compares to a balance sheet of 138 billion euros, according to its latest annual report.

A euro zone financial source in Brussels confirmed that raising the ECB's capital was one of the crisis management options under discussion. The ECB declined comment.

However, Trichet called in comments released on Tuesday for EU leaders to give maximum flexibility in size and scope to the euro zone's financial safety net, known as the European Financial Stabiility Facility (EFSF).

The rescue fund is limited by rules that specify it can only be used as a last resort and a requirement to maintain a cash buffer to preserve its top notch AAA credit rating.

MAXIMUM FLEXIBILITY

A senior EU source said experts were exploring ways around both restrictions to ensure the full 440 billion euros earmarked for the fund can be lent, and to provide a flexible credit line before a country is shut out of capital markets.

On the EFSF, I can say we are calling for maximum flexibility and I would say maximum capacity quantitatively and qualitatively, Trichet said at a Frankfurt International Business Journalists' Club event late on Monday.

Ireland became the first country to seek assistance from the EFSF this month as part of an 85 billion euro EU/IMF bailout after a banking crash swelled its public debt. Heavily indebted Greece received a separate 110 billion euro EU/IMF bailout in May just before the rescue fund was created.

The German official said no other country was in imminent need of EFSF aid. But Portugal and Spain are under bond market pressure to follow suit due to their high budget deficits and loss of economic competitiveness.

Spain had to pay a sharply higher yield than last month to sell 2.51 billion euros in 12- and 18-month bills on Tuesday after a renewed market sell-off that has driven up borrowing costs for Madrid and other vulnerable euro zone sovereigns.

Germany and its allies are seeking to prevent any discussion at the summit of a proposal by two veteran EU finance ministers for common euro zone bonds as a way to prevent speculation against member states' debt and reduce their borrowing costs.

The German official said the idea raised by Jean-Claude Juncker, chairman of euro zone finance ministers, and Italian Economy Minister Giulio Tremonti, would not be on the agenda.

LOSSES FEARED

ECB sources suggested the central bank wanted more capital chiefly to protect itself against potential losses rather than fund any major increase of euro zone government debt purchases.

The issue is that the ECB is worried about potential losses from its bond buying, one source said.

At the moment we are buying very modest amounts, but what if that is increased, and what if the bonds you buy are suddenly worth 30 percent less? the source said, referring to the risk of a writedown on a euro zone government's debt.

The ECB disclosed on Monday that it had increased purchases of euro zone government bonds to 2.667 billion euros ($3.5 billion) last week from 1.965 billion euros the previous week. It was the biggest weekly total since June but well below levels seen at the height of the euro zone crisis.

Altogether, the ECB has bought 72 billion euros in bonds -- exclusively Greek, Irish and Portuguese, analysts believe -- since it began intervening in May to stabilize markets.

ECB policymakers have repeatedly signaled that the central bank cannot bear the brunt of fire-fighting against bond market attacks on highly indebted euro zone states, urging governments to increase reform efforts and boost EU contingency funds.

Trichet urged euro zone countries to take action to ensure their banking sectors are appropriately restructured. The ECB is worried that ailing banks in weaker euro area countries have become totally dependent on central bank funding, making it harder to withdraw emergency liquidity support measures.

Figures released on Tuesday showed Spanish banks borrowed less from the ECB last month as funding conditions continued to improve. But Greek banks became even more dependent on the ECB lifeline, borrowing 95.1 billion euros in November, the Bank of Greece said.

(additional reporting by Marc Jones in Frankfurt, Paul Carrel in Berlin, Luke Baker in Brussels, Nigel Davies in Madrid and George Georgiopoulos in Athens; writing by Paul Taylor, editing by Mike Peacock)

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