Banks threaten to derail EU debt crisis strategy

THE WORLD’S biggest banks have threatened to disrupt Europe’s plan for Greece to default on its debt, a move which raises the stakes as EU leaders seek a deal tonight to settle the sovereign debt crisis.

With only hours to go before the leaders gather for an emergency summit, the banks have warned that they will not go along with Europe’s proposal for a “voluntary” initiative to write off “60 per cent or more” of Greece’s national debt.

In a sign of mounting tension, EU finance ministers scrapped plans for a pre-summit meeting this morning to review the new rescue package.

The effort is complicated by a deepening political crisis in Italy, as prime minister Silvio Berlusconi struggles to avert the collapse of his government over demands from Europe for new austerity measures.

The plan for a radical debt write-down by Greece has triggered fear that it could prompt panic in markets and speculation that other frail countries – Ireland among them – might follow suit.

Taoiseach Enda Kenny and other EU leaders insist that will not happen, saying Greece is a unique case. To guard against the threat of contagion, they plan to boost the firepower of Europe’s bailout fund and recapitalise weakened banks.

They have also pressed the banks that hold Greek debt not to seek compensation for their losses when their bonds are written down.

A European diplomatic source said the banks have baulked at that suggestion, saying they will seek compensation payments under a form of insurance contract known as a credit default swap.

This would severely compromise Europe’s effort to bring about a “managed” or “orderly” default by Greece, as any payout from credit default swaps would constitute a “credit event” for markets which would trigger the insurance contracts.

The authorities in Europe fear that this could spur a fresh upsurge of turmoil, similar to the shockwaves of disruption which the Lehman Brothers bankruptcy in 2008. This lies behind the push for a purely voluntary deal.

European negotiators have held inconclusive talks for days in Brussels with the Institute of International Finance, a lobby group which represents the world’s biggest banks. The group draws its directors from Deutsche Bank, Commerzbank, Goldman Sachs, UBS, HSBC and Morgan Stanley.

The banks have refused to co-operate. They argue that a big write-down for Greece would be precedent-setting, creating the possibility that other countries would meet the same fate. The effective deadline for the talks with the banks is a 6pm summit of the leaders of the 27 EU countries, who will review the rescue plan before the 17 euro zone leaders take the final decision.

Before these meetings, German chancellor Angela Merkel will ask the German parliament to endorse the latest plan to expand Europe’s bailout fund.