* France wants to tap EFSF for its banks -German source
* Merkel says EFSF only a last resort
* Merkel, Sarkozy to discuss euro zone crisis on Sunday
By Matthias Sobolewski and Paul Taylor
BERLIN/PARIS, Oct 7 Germany and France were
split ahead of crucial talks on Sunday over how to strengthen
shaky European banks and fight financial market contagion to
prepare for a possible Greek default.
Under strong U.S. and market pressure Chancellor Angela
Merkel and President Nicolas Sarkozy will try to bridge
differences on how to use the euro zone's financial firepower
to counter a sovereign debt crisis that threatens the global
A ratings downgrade on both Italy and Spain by Fitch
Ratings on Friday underscored the grim climate.
A German source said Paris wanted to be able to tap the
euro zone's 440 billion euro rescue fund to recapitalize its
own banks, which have the largest exposure to peripheral euro
zone debt, while Berlin insisted the fund should be used only
as a last resort when no national funds are available.
After meeting Dutch premier Mark Rutte, Merkel confirmed
the German position was that the European Financial Stability
Facility was a backstop to be used "only if that country is
unable to cope on its own."
A French Treasury source told Reuters that Paris believed
banks unable to raise capital on the open market should be able
to tap the fund, but talk of divergences with Berlin was
premature since the issue had not yet been debated.
Merkel said struggling banks should look first to the
markets, then their national government, and only in the last
instance the EFSF, and with reforms as a strict condition.
"This will definitely be discussed at the next summit," she
said, referring to an EU leaders meeting on Oct. 17 and 18 for
which she and Sarkozy will attempt to set the agenda.
The French government and the Bank of France had dismissed
until this week any need to recapitalize French banks and are
now wrangling over how to do it in a way that does not put the
country's top-notch credit rating at risk.
"I hear that the French are scared that too much bank
recapitalization could jeopardize the French AAA and that is
why they push for the EFSF solution for French banks. I expect
Merkel to stick to national funds for recapitalization," said
economist Jacques Delpla, a member of the French government's
advisory council of economic analysis.
France has the highest debt-to-GDP ratio of any of the six
triple-A countries in the euro zone at 86.2 percent.
If France, the second largest guarantor of the rescue fund
after Germany, were to lose its top-notch rating, the whole
edifice of financial support for Greece, Portugal and Ireland
A senior European diplomat said that because of its
exposure and concern for its credit rating, France was more
hesitant than Germany or Britain about the need to restructure
Greece's debts and take losses as soon as possible.
Preserving France's AAA status was politically sensitive
seven months before a presidential election in which Sarkozy is
trailing the opposition Socialists in opinion polls, he said.
Many major European banks continue to insist they need no
more capital, although the International Monetary Fund says up
to 200 billion euros must be injected.
The chief executive of Societe Generale ,
Frederic Oudea, told Reuters Insider TV the main problem was
not one of capital but liquidity as interbank lending dries up.
"The main issue is a crisis of confidence in the sovereign.
... What is important is to deal with the Greek issue as
quickly as possible and then rebuild confidence in the capacity
of each bank in Europe to reduce its debt," Oudea said at
SocGen's Paris headquarters.
Some banks are clearly in need, however.
France and Belgium are arguing over whose taxpayers should
pay to salvage cross-border municipal lender Dexia ,
which came close to collapse this week and is to be broken up.
Moody's Investor Service on Friday said it may cut
Belgium's credit rating.
U.S. President Barack Obama implored European leaders on
Thursday to come up with a plan before a Group of 20 major
economies summit in Cannes, France, on Nov. 3-4, saying the
euro zone crisis was the biggest cloud over the U.S. economy.
Bank of Japan Governor Masaaki Shirakawa said on Friday
that the European sovereign debt woes were putting Japan's
economy under growing strain.
Shirakawa told a news conference in Tokyo that "global
growth is slowing as a trend" and European growth was
"stalling" as debt worries mount.
European Commission President Jose Manuel Barroso said on
Thursday the EU's executive arm was preparing a plan for bank
recapitalization across the 27-nation bloc.
However, other EU officials have made clear it would only
be a set of guidelines for national measures and an approach
for cross-border banks, and not a common European mechanism or
mandatory rules on recapitalization.
The European Banking Authority, which coordinates national
regulators, is reassessing banks' capital buffers based on data
provided for stress tests conducted in July, which showed that
only eight banks failed, requiring just 2.5 billion euros in
A euro zone supervisory source said a figure of 180-200
billion euros cited by International Monetary Fund and private
economists reflected the impact of writing down sovereign bond
holdings to current low market prices and assuming that Greece
and perhaps another country would default.
Both Merkel and Sarkozy have reaffirmed in the last week
that a Greek default must be avoided because it would have
potentially catastrophic consequences for the European and
The French Treasury source said Paris was open to modifying
some elements of a July 21 agreement by euro zone leaders to
make private bondholders share the cost of a second bailout for
Greece, such as debt maturities and interest rates, but a
full-scale rewrite was undesirable.
German and Finnish officials argue that since market
conditions have changed, banks may need to take more than the
agreed 21 percent write-down on their Greek holdings.
A team of EU and IMF inspectors is continuing negotiations
with Greece on reforms required to release a vital 8 billion
euro aid installment by mid-November.
Fitch late Friday cut Italy's sovereign credit rating by
one notch and Spain's by two, citing a worsening of the euro
zone debt crisis and a risk of fiscal slippage in both states.
The downgrades knocked the wind out of the euro, which
slipped 0.3 percent to $1.3388 , leaving it rooted in a
downtrend that began at $1.4548 on Aug. 29.
Italy's rating fell to A-plus from AA-minus, and Spain's
was lowered to AA-minus from AA-plus. Both countries,
respectively the third and fourth largest economies in the euro
zone, were placed on a negative outlook suggesting further
downgrades could come in future.