Germany and France have ruled out a bank tax after reaching a common position on a second bailout of Greece to prevent the country's debt crisis spreading through Europe, EU sources said on Thursday.
The accord came after seven hours of talks late into Wednesday night between German Chancellor Angela Merkel and French President Nicolas Sarkozy in Berlin, sources in both governments said.
European Central Bank President Jean-Claude Trichet joined Merkel and Sarkozy for part of their talks and one source said their agreement, kept secret to avoid offending other euro group leaders at a summit on Thursday, had his blessing.
You should assume that there will not be a banking tax, the source told Reuters.
Another source involved in preparatory talks for the emergency summit of the 17-nation currency area confirmed that the banking tax proposal, raised last week, had been dropped.
While few details of the Franco-German deal emerged, the sources said it would include private sector involvement that should not cause either a default or selective default of Greek debt, a red line for the ECB.
The risk premium investors demand to hold peripheral euro zone government bonds rather than benchmark German Bunds fell on Thursday on news of the Franco-German agreement.
There are huge expectations something will be done... the big disappointment could come from how quickly they can implement things. They can agree principles but implementation will take a long while, said Peter Schaffrik, a strategist at RBC Capital Markets.
The 115 billion euro second Greek rescue package would involve both more official funding from the euro zone rescue fund and the IMF and a contribution by private sector bondholders on which two senior bankers will make a presentation to leaders on Thursday, the sources said.
Baudoin Prot of BNP Paribas, the French bank with the biggest exposure to Greek debt, and Deutsche Bank chief executive Josef Ackermann, chairman of the International Institute of Finance, a banking lobby that has led talks among bankers, will attend, banking sources said.
The leaders are due to meet at 1100 GMT but the start could well be delayed as euro zone sherpas work to thrash out details of an agreement, officials said.
The aim is to make Greece's debt more sustainable and prevent fears of a disorderly default from poisoning access to the bond market for bigger states such as Italy and Spain.
The new bailout would supplement a 110 billion euro ($156 billion) rescue plan for Greece launched in May last year. Ireland and Portugal have since received similar rescues and Italian and Spanish debt has come under attack this month, spreading the crisis to countries that are too big to save with the EU's current fire-fighting instruments.
Worried about the impact on financial markets and wary of angering their own taxpayers, euro zone governments have struggled for several weeks to agree on major aspects of the plan, especially a contribution by private sector investors.
The euro rose moderately against the dollar in response to the Franco-German announcement. Providing fresh money to Greece and arranging for commercial banks to participate could face legal and technical obstacles.
The head of the European Commission, Jose Manuel Barroso, warned on Wednesday that the global economy would suffer if Europe could not summon the political will to act decisively on Greece.
Nobody should be under any illusion: the situation is very serious. It requires a response, otherwise the negative consequences will be felt in all corners of Europe and beyond, Barroso told a news conference.
Britain's finance minister George Osborne, in an interview with the Financial Times published on Thursday, said failure could produce an economic crisis as serious as the recession which followed the global credit crash of 2008.
Barroso said a solution to Greece's problems must include steps to ensure the sustainability of Greek public finances, private sector involvement in funding for Athens, more flexible use of the euro zone's bailout fund, repair of the region's banking system, and liquidity to keep the Greek economy going.
It was not clear how many of these steps were included in the Franco-German accord.
Four competing proposals have been circulating for private sector involvement: a rollover of Greek government bonds as they mature, a swap of bonds for debt with longer maturities, a buy-back of Greek debt at a discount to its face value, and a tax on European banks.
Germany and France had been at odds on these proposals, with Berlin promoting a bond swap and France suggesting a rollover or a tax. The ECB had complicated the argument by opposing any step that might cause credit rating agencies to declare Greek debt in default.
The IMF, whose new head Christine Lagarde will also attend, has told euro zone leaders they should put more money into their bailout fund, the 440 billion euro European Financial Stability Facility, and let it buy government bonds of weak states on the secondary market. Investors also hope it will be permitted to extend precautionary credit lines to countries at risk.
Germany has previously blocked allowing the EFSF to buy bonds, which would require changes in the fund's rules that would have to be ratified by national parliaments, and could fall foul of critics in Germany, the Netherlands and Finland.
Regardless of the details of the Franco-German accord, Thursday's summit is very unlikely to mark a complete resolution of the crisis, as Merkel herself acknowledged earlier this week.
A second bailout may simply keep Greece afloat for a number of months before a tougher decision has to be made on writing off more of its debt.
In any case, many economists believe the only way out of the euro zone's debt crisis in the long run may be closer integration of national fiscal policies -- for example, a joint euro zone guarantee for countries' bonds, or issuance of a joint euro zone bond to finance all countries.
Germany has firmly ruled out such steps, but Osborne said the second Greek bailout would only be a step toward a necessary fiscal union in the euro zone.
(additional reporting by Emmanuel Jarry in Berlin, Philipp Halstrick in Frankfurt, Emilia Sithole-Matarise in London; writing by Andrew Torchia and Paul Taylor, editing by Janet McBrde)