Geman Chancellor Angela Merkel and French President Nicolas Sarkozy will  to discuss the euro crisis on Sunday.

Story highlights

Angela Merkel and Nicolas Sarkozy will talk on Sunday on the EU debt crisis

Will attempt to reconcile French and German differences on how to fight the crisis

Financial Times  — 

Angela Merkel and Nicolas Sarkozy will talk on Sunday in an attempt to reconcile the differences between Germany and France over how to tackle the eurozone financial crisis and fund an expected recapitalisation of European banks.

The talks between the German chancellor and French president will focus on how to prevent contagion spreading as the soaring cost of government debt in peripheral eurozone members, such as Greece and Italy, has undermined confidence in European banks because of their holdings of sovereign debt.

The two leaders’ longer-term plans for a new layer of “economic governance” to co-ordinate the fiscal policies in the 17-member currency union also face resistance from smaller countries, fearful that they may lead to big country domination, and reduce the role of the European Commission.

Despite protestations to the contrary, divisions have emerged between the two capitals on how to maximise the use and effectiveness of the eurozone’s emergency rescue fund – the €440bn ($590bn) European financial stability facility – and whether to use it to top up the capital resources of banks holding large amounts of downgraded eurozone government debt.

Ms Merkel, the German chancellor, is resisting moves to leverage the funds available to the EFSF, to expand its capacity to buy eurozone sovereign bonds and provide precautionary loans to governments facing liquidity difficulties. France wants to maximise the firepower of the fund, to stem the danger of contagion from the financial crisis in Greece and other peripheral eurozone members.

Berlin is also adamant that any bank recapitalisation should be financed first by the banks themselves and second by their national governments, before there is any recourse to the EFSF for funds.

Paris played down the differences on Friday, insisting that there was “no divergence” between the two capitals on the question of bank recapitalisation.

“We are agreed with Germany that it is a fact that the banks must have more capital, including the French banks,” said François Baroin, French finance minister.

President Sarkozy met Christine Lagarde, head of the International Monetary Fund, for an hour in Paris on Saturday, ahead of his meeting with Ms Merkel.

Ms Lagarde was the first to call for an urgent recapitalisation of European banks in August, at the time irritating European leaders. The IMF estimates the cost of a Europe-wide recapitalisation at €100bn-€200bn.

As French finance minister until she joined the IMF in the summer, Ms Lagarde is well positioned to help reconcile the positions of Paris and Berlin. Neither Mr Sarkozy nor Ms Lagarde made any comment after their talks.

Ms Merkel spelt out a three-step process of recapitalisation on Friday, insisting that the eurozone rescue fund should only be used in extreme circumstances, and subject to strict conditionality, if a eurozone government said it was “unable to cope on its own.”

She stopped short of calling for recapitalisation, saying only that “we will follow the advice of our experts … if they say we must recapitalise.”

Mr Baroin agreed that in the first instance the sources of new bank capital should be private, with public funds being used “only as a last resort”. There were several options for this “but we have not yet discussed these at the European level”, he added.

French officials have stressed that the country’s banks are taking steps to meet minimum capital requirements set under the Basel III regulations by 2013, and continuing to insist that they do not need more capital despite their big exposure to risky eurozone sovereign debt.

Speaking after talks with Mark Rutte, the Dutch prime minister, the chancellor stressed the close convergence of their views and the need to involve all 27 EU member states in any agreement. She also gave her blessing to a Dutch plan for a European commissioner to be appointed to police the fiscal rules of the eurozone.

Another division between France and Germany has been apparent on plans to review the terms of private bondholders’ involvement in a further Greek rescue package, agreed in July by eurozone leaders.

Germany is one of several eurozone countries trying to revise the terms of the deal, according to which banks and other financial institutions agreed to roll over or swap their bonds, taking a notional 21 per cent “haircut”, at a time when the Greek paper is trading far lower in financial markets.

French officials accept that the private sector will have to make a bigger contribution to supporting Greece than the “haircut” on Greek sovereign debt already agreed.

Paris is open to “technical amendments”, they said but this could be done via maturities and interest rates, rather than by “renegotiating something completely different”.