Germany and France divided on fund use

GERMANY and France were split ahead of crucial talks tomorrow over how to strengthen shaky European banks and fight financial market contagion to prepare for a possible Greek default.

Under strong US and market pressure, German Chancellor Angela Merkel and French President Nicolas Sarkozy will try to bridge differences on how to use the eurozone’s financial firepower to counter a sovereign debt crisis that threatens the global economic recovery.

A German source said Paris wanted to be able to tap the eurozone’s €440 billion rescue fund to recapitalise its own banks, which have the largest exposure to peripheral eurozone debt, while Berlin insisted the fund should be used only as a last resort when no national funds are available.

After meeting Dutch prime minister Mark Rutte, Ms Merkel confirmed the German position was that the European Financial Stability Facility (EFSF) was to be used “only if that country is unable to cope on its own”.

A French Treasury source said 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.

Ms 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 October 17 and 18 for which she and Mr Sarkozy will attempt to set the agenda.

The French government and the Bank of France had dismissed until this week any need to recapitalise its banks and are now wrangling over how to do it in a way that does not put Paris’ top-notch credit rating at risk.

A senior EU diplomat said the dispute surfaced in a tough discussion among eurozone officials this week over whether the EFSF could be used for banks on a “precautionary” basis or only as a last resort.

The Brussels diplomat said France’s approach was driven by its determination to limit any risk to its AAA credit rating. France has the highest debt-to-GDP ratio of any of the six triple-A countries in the eurozone at 86.2%.

“The bottom line for France is the AAA, and that’s why the are pushing to do it [recapitalisation] through the EFSF,” he said.

If France, the second largest guarantor of the rescue fund, were to lose its top-notch rating, the whole edifice of financial support for Greece, Portugal and Ireland would crumble.