UPDATE 2-Merkel, Sarkozy tackle differences over euro crisis

* Merkel, Sarkozy to meet in Berlin late on Sunday
* Will discuss differences on bank capital, EFSF bond buying
* Meeting occurs as crisis risks spiralling into banking
meltdown
By Sarah Marsh and Yann Le Guernigou
BERLIN, Oct 9 (Reuters) - German Chancellor Angela Merkel
will thrash out differences with French President Nicolas
Sarkozy on Sunday over how to use the euro zone's financial
firepower to counter a sovereign debt crisis threatening the
global economy.
With the turmoil threatening to spiral into financial
meltdown as the value of banks' sovereign bond holdings slide,
Merkel and Sarkozy are likely to discuss in Berlin both how to
manage Greece, prevent contagion and strengthen lenders.
The implosion of Belgian lender Dexia , the first
victim of the crisis, has added a sense of urgency to the talks.
The prime ministers of France and Belgium and the finance
minister of Luxembourg agreed a rescue plan for Dexia on Sunday
ahead of the stricken Franco-Belgian bank.
"Dexia will be among the topics that will be discussed but
the main topic is Greece and the euro zone, as banks are only a
consequence" of the crisis, a source at the French finance
ministry told Reuters.
Sarkozy is due to arrive in Berlin late on Sunday afternoon
and hold a meeting with Merkel followed by a working dinner. A
news conference will take place at 1530 GMT.
Talks are continuing over a vital aid tranche for Greece,
which could run out of cash as soon as mid-November. European
finance ministers are considering making banks take bigger
losses on Greek debt -- an issue that could be discussed at the
Merkel-Sarkozy meeting.
"It is possible that we assumed in July a level of debt
reduction that was too low," German Finance Minister Wolfgang
Schaeuble was cited as saying by a newspaper on Sunday.
Separately, European Commission head Jose Manuel Barroso
told Bild a Greek default would have unforeseeable consequences
and may cause the crisis to spread.
"This is new territory for us and we are discussing
solutions which have not really been tested before," he said.
BOLSTERING BANKS
Germany and France have so far been split over how to
recapitalise Europe's banks, which Ireland estimated on Saturday
may need more than 100 billion euros ($135 billion) to withstand
the sovereign debt crisis, while the International Monetary Fund
(IMF) has said the banks need 200 billion in additional funds.
Paris wants to tap the euro zone's 440 billion European
Financial Stability Facility (EFSF) to recapitalise its own
banks, while Berlin is insisting the fund should be used as a
last resort.
Qatar is being cited by some media as a potential saviour
for European banks yet analysts believe tiny Gulf Arab state is
an unlikely white knight, as Europe's needs are too great.
Top French banks BNP Paribas and Societe Generale
denied a report on Sunday that they could seek to
raise a combined 11 billion euros as part of a broader European
bank recapitalisation plan.
Another key dispute is how to use the EFSF to buy sovereign
debt to prevent contagion of the crisis, particularly crucial if
Greece fails to secure its next aid tranche.
France does not want to set guidelines for the EFSF on the
matter, whereas Germany wants to limit the sum used for each
member state and set a time limit for bond purchasing.
"Given that the EFSF is limited overall, it makes sense also
to limit the purchases on the secondary market for each
country," Michael Meister, deputy parliamentary leader of
Merkel's conservatives, told Reuters.
There was a danger, otherwise, the funds could be quickly
used up, he said.
Berlin could be prepared to allow a more flexible use of the
EFSF to prop up states and banks if Paris agrees to a broad
haircut on Greek debt, a German paper wrote on Sunday.
But a government source told Reuters: "There is no such
agreement". Furthermore, Merkel warned last Tuesday that the
threat of contagion from a euro zone country rescheduling its
debt would be huge, and it only made sense once it had achieved
a primary surplus again.
The two euro zone heavyweights have come under pressure
worldwide to resolve Europe's crisis which is roiling markets.
U.S. President Barack Obama on Thursday urged Europe to "act
fast", calling the common currency bloc's crisis the largest
obstacle to the United States' own recovery.
World Bank President Robert Zoellick told Wirtschaftswoche
magazine there was a "total lack" of vision in Europe and
Germany in particular needed to show more leadership.
Merkel will visit Vietnam and Mongolia this coming week.