UPDATE 2-Merkel, Sarkozy tackle differences over euro crisis
* Merkel, Sarkozy to meet in Berlin late on Sunday
* Will discuss differences on bank capital, EFSF bond buying
* Meeting occurs as crisis risks spiralling into banking meltdown
By Sarah Marsh and Yann Le Guernigou
BERLIN, Oct 9 (Reuters) - German Chancellor Angela Merkel will thrash out differences with French President Nicolas Sarkozy on Sunday over how to use the euro zone's financial firepower to counter a sovereign debt crisis threatening the global economy.
With the turmoil threatening to spiral into financial meltdown as the value of banks' sovereign bond holdings slide, Merkel and Sarkozy are likely to discuss in Berlin both how to manage Greece, prevent contagion and strengthen lenders.
The implosion of Belgian lender Dexia , the first victim of the crisis, has added a sense of urgency to the talks. The prime ministers of France and Belgium and the finance minister of Luxembourg agreed a rescue plan for Dexia on Sunday ahead of the stricken Franco-Belgian bank.
"Dexia will be among the topics that will be discussed but the main topic is Greece and the euro zone, as banks are only a consequence" of the crisis, a source at the French finance ministry told Reuters.
Sarkozy is due to arrive in Berlin late on Sunday afternoon and hold a meeting with Merkel followed by a working dinner. A news conference will take place at 1530 GMT.
Talks are continuing over a vital aid tranche for Greece, which could run out of cash as soon as mid-November. European finance ministers are considering making banks take bigger losses on Greek debt -- an issue that could be discussed at the Merkel-Sarkozy meeting.
"It is possible that we assumed in July a level of debt reduction that was too low," German Finance Minister Wolfgang Schaeuble was cited as saying by a newspaper on Sunday.
Separately, European Commission head Jose Manuel Barroso told Bild a Greek default would have unforeseeable consequences and may cause the crisis to spread.
"This is new territory for us and we are discussing solutions which have not really been tested before," he said.
Germany and France have so far been split over how to recapitalise Europe's banks, which Ireland estimated on Saturday may need more than 100 billion euros ($135 billion) to withstand the sovereign debt crisis, while the International Monetary Fund (IMF) has said the banks need 200 billion in additional funds.
Paris wants to tap the euro zone's 440 billion European Financial Stability Facility (EFSF) to recapitalise its own banks, while Berlin is insisting the fund should be used as a last resort.
Qatar is being cited by some media as a potential saviour for European banks yet analysts believe tiny Gulf Arab state is an unlikely white knight, as Europe's needs are too great.
Top French banks BNP Paribas and Societe Generale denied a report on Sunday that they could seek to raise a combined 11 billion euros as part of a broader European bank recapitalisation plan.
Another key dispute is how to use the EFSF to buy sovereign debt to prevent contagion of the crisis, particularly crucial if Greece fails to secure its next aid tranche.
France does not want to set guidelines for the EFSF on the matter, whereas Germany wants to limit the sum used for each member state and set a time limit for bond purchasing.
"Given that the EFSF is limited overall, it makes sense also to limit the purchases on the secondary market for each country," Michael Meister, deputy parliamentary leader of Merkel's conservatives, told Reuters.
There was a danger, otherwise, the funds could be quickly used up, he said.
Berlin could be prepared to allow a more flexible use of the EFSF to prop up states and banks if Paris agrees to a broad haircut on Greek debt, a German paper wrote on Sunday.
But a government source told Reuters: "There is no such agreement". Furthermore, Merkel warned last Tuesday that the threat of contagion from a euro zone country rescheduling its debt would be huge, and it only made sense once it had achieved a primary surplus again.
The two euro zone heavyweights have come under pressure worldwide to resolve Europe's crisis which is roiling markets. U.S. President Barack Obama on Thursday urged Europe to "act fast", calling the common currency bloc's crisis the largest obstacle to the United States' own recovery.
World Bank President Robert Zoellick told Wirtschaftswoche magazine there was a "total lack" of vision in Europe and Germany in particular needed to show more leadership.
Merkel will visit Vietnam and Mongolia this coming week.
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