Banks agree 50 per cent loss on Greek debt

European Union leaders early this morning reached agreement on what they described as a "comprehensive set of additional measures" to tackle the sovereign debt crisis and stabilise the banking system – including asking private creditors to take a 50 per cent haircut on Greek debt.

Following a 10 hour emergency summit in Brussels, which dragged into the early hours of this morning, leaders agreed to boost the eurozone bail-out mechanism from €440bn to €1tn. On top of accepting a 50 per cent loss on their holdings of Greek debt, banks will have to recapitalise to the tune of about €106bn by next summer. And Greece will receive a further €100bn in assistance from the EU and International Monetary Fund from the beginning of next year – as well as a €30bn contribution to ease private sector losses.

The deal had appeared under threat last night when the managing director of the Institute for International finance, Charles Dallara, released a statement saying there was "no agreement on any element of the deal". Banks had been unwilling to accept losses on Greek debt of more than 40 per cent, but a last minute agreement was brokered for Greek bonds to be swapped for new loans. Under the plan for recapitalisation banks will have to bring the level of their highest quality capital to 9 per cent by June next year. Banks' payments of bonuses and dividends will be "constrained" until the target is reached, EU leaders said.

Two methods of leveraging the European Financial Stability Facility – which has about €250bn left following bail-outs of Greece, Portugal and Ireland – were endorsed to increase the amount available to €1tn without extra guarantees. The first is to give credit enhancement to sovereign bonds issued by member states. The second involved in the creation of a so-called Special Purpose Vehicle to attract investment from the IMD and economies such as China which have expressed an interest. French President Nicolas Sarkozy will meet Chinese premier Hu Jintao today as part of preparations for a G20 meeting on 3 November.

The euro rose to a seven-week high against the dollar following the conclusion of the summit, and this morning stock markets were up across Europe – suggesting that the deal had at least bought some time. President of the European Commission José Manuel Barroso said: "The package that we have agreed tonight, a comprehensive package, confirms that Europe will do what it takes to safeguard financial stability. I've said it before and I'll say it again, this is a marathon not a sprint." He added that technical work to finalise the details of the deal's complexities would be completed in the coming weeks.

In a 15-page summit communiqué EU presidents and prime ministers said they agreed on a "comprehensive set of additional measures reflecting out strong determination to do whatever is required to overcome the present difficulties and take the necessary steps for the completion of our economic and monetary union". Afterwards President of the European Council Herman Van Rompuy, who chaired the meeting, remarked: "We do not want to repeat some of the errors of the recent past. In taking today's decisions, we lay the foundations for our future. All members of the Euro Summit are determined to follow this path."

Sarkozy described the deal as "credible" and "ambitious" while German Chancellor Angela Merkel said leaders had "done what needed doing". Meanwhile Greece will see its debt reduced from a projected peak of 186 per cent of gross domestic product to 120 per cent by 2020, and Prime Minister George Papandreou said: "We can claim that a new day has come for Greece, and not only for Greece but also for Europe." But that new era will include some loss of sovereignty after Germany insisted that an economic supervisory group be based in Greece for the duration of the assistance programme in addition to the regular visits of the troika.

Italian Prime Minister Silvio Berlusconi's expressed commitment to balance his country's budget by 2013 and reduce its debt burden to 113 per cent of GDP by 2014 was welcomed at the summit. Berlusconi, who has been the focus of the debt crisis in recent days, has been under intense pressure to implement further austerity measures and structural changes, including pension reform, to pull Italy back from the brink of economic collapse. Spain, meanwhile, was praised for the progress it has made on reducing its deficit. The ECB, which began purchasing Spanish and Italian bonds in August to bring down government borrowing costs, is expected to continue to purchase bonds on the secondary market.

Van Rompuy, Barroso and President of the Eurogroup Jean-Claude Juncker were asked to look into way that economic integration in the eurozone could be advanced – including through limited treaty changes. They will present their initial findings in December and publish a report in March 2012. Leaders reiterated their commitment to the single currency: "The euro is at the core of our European project. We will strengthen the economic union to make it commensurate with the monetary union." The communiqué set out 10 measures to boost economic coordination, including holding Euro Summits twice a year. And British Prime Minister David Cameron has advocated a non-euro group to ensure the voices of member states outside the eurozone are heard.

Reactions from the European Parliament were mixed. President Jerzy Buzek said the deal inspired hope that the crisis would be contained, but said the EU needed to "pursue vigorously a pro-growth agenda" alongside austerity. Likewise Joseph Daul, chairman of the centre-right European People's Party said much more needed to be done, "in particular adopting a new model of economic governance, without which the euro cannot operate sustainably". And the creation of a European Monetary Fund and a single European bond market remain on the wish list of Alliance of Liberal and Democrats leader Guy Verhofstadt despite his relief that "after two years of delay and hesitation EU leaders finally realised their backs were against the wall".

The European Conservatives and Reformists were more critical, suggesting that EU leaders had merely "rearranged the deck chairs on the Titanic". Leader Jan Zahradil said: "A vast amount of both private and public funds will be poured into the debt bail out. Other debts will simply be written off and a bond union will be created. We are at the beginning of massive fiscal transfers that we have never seen before in our history," adding that the consequences would political and social as well as economic. Meanwhile co-presidents of the Green/European Free Alliance Dany Cohn-Bendit and Rebecca Harms said the agreement did not provide a definitive answer, lacked clarity and amounted to "ad-hoc firefighting".

If similar decision had been made a year ago "we wouldn't be in this position today," said Socialists and Democrats leader Martin Schulz. And there was a further note of caution from Liberal Democrat Sharon Bowles, who chairs the parliament's economic and monetary affairs committee. She warned that both options for leveraging the EFSF were "giant experiments and not without risk". She said: "The insurance option has some similarity to mortgage and United States department guarantees, whilst the SPV option has similarities with structured products. Despite popular sentiment going against such financial engineering, some such mechanisms have performed well through the recession, so they should not be discounted."

The deal to expand the EFSF was still vague, according to Professor Philip Booth of Cass Business School. "It is possible that huge upfront guarantees by EU governments have been avoided but only at the expense of loading even bigger burdens onto EU governments should there be a default in the future. This is a high-risk strategy for the EU member states. If Italy undergoes radical reform to raise its growth rate, the eurozone might just contain this crisis to Greece. However, if Italy does not undertake reform, the crisis will simply get worse."