* Paris, Berlin disagree over how to strengthen rescue fund
* Big finance lobbies for EU to insure bonds
* EU agrees 90-100 bln euros needed to recapitalise banks
* IMF/EU at odds over Greek debt projections - officials
* S&P says likely to downgrade France if euro zone recession
By Alexandra Hudson and Luke Baker
BRUSSELS/BERLIN, Oct 21 France's push to use
more European Central Bank money to fight the euro zone debt
crisis ran into strong resistance from Germany and other EU
partners on Friday, leaving Paris increasingly isolated before a
The rift between Europe's two biggest powers has already
forced leaders to tack on an extra summit in the coming week.
They will now meet twice -- on Sunday and Wednesday -- to
adopt a comprehensive strategy to fight the crisis that began in
Greece, spread to Ireland and Portugal and is now threatening to
engulf bigger economies in the 17-nation currency area.
Senior European sources said Berlin and Paris were still at
loggerheads on two core elements of a plan to build a firewall
around Greece and stabilise bond markets -- how to scale up the
euro zone's rescue fund, the European Financial Stability
Facility (EFSF), and how to reduce Greek debt.
French President Nicolas Sarkozy appeared isolated after an
acrimonious meeting in Frankfurt on Wednesday in seeking to turn
the 440-billion-euro ($600 billion) EFSF rescue fund into a bank
able to access ECB liquidity to fight contagion, and would have
to back down, the sources said.
Germany, the ECB itself and the European Commission all
argued that the move would violate an EU treaty prohibition on
monetary financing of governments.
"The path is closed for using the ECB to ease liquidity
problems," German Chancellor Angela Merkel told conservative
lawmakers in Berlin, participants at the private meeting said.
Merkel and Sarkozy will try to resolve their differences
over dinner in Brussels on Saturday night, officials said.
Finance Minister Wolfgang Schaeuble hammered home Berlin's
message at a preparatory meeting of euro zone finance ministers
in Brussels, telling reporters: "We will stick to the situation
as it is in the treaty that the central bank is not available
for state financing."
A German government spokesman said major decisions at the
two-part meeting would only come on Wednesday. Merkel needed
time to secure parliamentary support under new rules that
stipulate that the Bundestag's budget committee must approve all
key EFSF decisions.
The timetable forced the EU to postpone a summit with China
next Tuesday, highlighting how the debt crisis is impinging on
Europe's place in the world.
Striking a new note of exasperated urgency, Chinese Premier
Wen Jiabao told European Council President Herman Van Rompuy in
a phone call that European leaders should take concrete actions
to contain the crisis and stabilise the euro and financial
The summits' outcome will determine whether investor
confidence in the euro area can be restored. It will also
influence whether an expected Greek debt write-down triggers a
chain reaction of financial turmoil across Europe.
As a first step, leaders of the 27-nation European Union are
set to endorse a plan on Sunday to strengthen banks' capital
base and may also launch a procedure for longer-term reform of
the euro area's economic governance, EU sources said.
European banks will be required to increase their core tier
one capital ratio to 9 percent to help them withstand losses on
sovereign debt, but it is not yet agreed how long they will be
given to raise extra funds.
EU officials said the total amount required was just short
of 100 billion euros. Those banks that cannot raise money on the
markets will have to turn to national governments.
FRENCH RATING IN SPOTLIGHT
An EU source said France, which has presidential and
parliamentary elections from April to June and is desperate to
keep its top-notch AAA credit rating, was pressing for banks to
be given at least nine months to meet the target.
France fears its credit rating could come under threat if
the wrong method is chosen to scale up the bailout fund to
prevent contagion spreading to Italy and Spain, the euro zone's
third and fourth largest economies.
Ratings agency Standard & Poor's said on Friday it was
likely to downgrade France and four other states if Europe slips
into recession. It was the second agency this week to cast doubt
on Paris' rating after Moody's on Tuesday.
There are also differences between Germany and France and
between the EU and the International Monetary Fund over how deep
a write-down banks and insurers will have to take on Greek bond
holdings to make that country's debt sustainable.
Paris and Berlin called on Thursday for negotiations to
start immediately with the private sector over its contribution
to a sustainable plan for Greece's mountainous debt.
Underlining the threat the euro zone crisis poses to the
global economy, U.S. President Barack Obama held a video
conference with Merkel and Sarkozy on Thursday, reiterating that
he hopes a solution will be in place in time for a summit of G20
leaders in Cannes, France on Nov.3-4.
The IMF is more pessimistic than the EU about the
sustainability of Greek debts and believes that a deeper debt
reduction is needed, EU sources told Reuters.
Despite the differences, EU and IMF 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.
HOW TO SCALE UP
The biggest challenge is agreeing on the method of scaling
up the EFSF.
The most likely approach is to use the EFSF to guarantee a
portion of potential losses on new euro zone bonds, a way of
trying to restore market confidence. But ministers stressed
other options were still on the table.
A group of 10 major financial companies, including banks,
insurers and global bond fund giant PIMCO, wrote to EFSF chief
Klaus Regling on Friday, saying partial insurance of sovereign
bonds could be a viable instrument to secure private funding for
euro zone states "if implemented in size".
"The ability of the EFSF to potentially write significant
amounts of such "insurance" without any further increase to the
existing commitments should be an important element in any
comprehensive plan by the European government to address the
crisis," the letter seen by Reuters said.
By guaranteeing only a portion, perhaps a third or a fifth,
of each debt issue, the available EFSF funds could stretch 3-5
times further, increasing it to around 1 trillion euros.
However, 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
could exacerbate market turmoil.
Despite the pre-summit cacophony, European shares
and the euro rose on investors' hopes that European
leaders were at last working on a comprehensive plan.
Adding to uncertainty, EU officials said some key euro zone
member states were coming to the view that further private
sector involvement in Greek debt reduction may have to be
forced, not voluntary -- an outcome ruled out up to now.
In July, banks and insurers 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 this year, or 162 percent
of annual economic output. German government sources said Greek
debt should be reduced to about 120 percent of GDP.