(Reuters) - The leaders of France and Germany will not leave this week's EU summit until a "powerful" deal is reached to arrest the euro zone debt crisis, Paris said on Wednesday, as new figures exposed ever more severe stress among Europe's banks.
French President Nicolas Sarkozy and German Chancellor Angela Merkel will lay out a plan at Friday's European Union summit to impose mandatory penalties on euro states that exceed deficit targets, aiming to restore market trust and prevent the region's debt crisis spiraling out of control.
But while Paris voiced determination, a senior German official gave a deliberately downbeat assessment of prospects for an agreement in an apparent effort to jolt partners into accepting Berlin's terms and restrictions.
"I have to say today, on Wednesday, that I am more pessimistic than last week about reaching an overall deal ... A lot of protagonists still have not understood how serious the situation is," the official told a pre-summit briefing.
"My pessimism stems from the overall picture that I see at this point, in which institutions and member states will have to move on many points to make possible the new treaty rules that we are aiming for," he said, speaking on condition of anonymity.
U.S. Treasury Secretary Timothy Geithner, on a tour of Europe to lobby for action, voiced confidence in the Franco-German plan to overhaul the EU treaty to anchor tighter budget discipline.
"I have a lot of confidence in what the president of France and the minister are doing, working with Germany to build a stronger Europe," Geithner told reporters after talks with French Finance Minister Francois Baroin.
"Neither Nicolas Sarkozy nor Angela Merkel will leave the negotiating table of this summit until there is a powerful deal," Baroin told Canal+ television.
Figures released on Wednesday showed just how urgently some European banks need help.
Italian banks had to borrow 153.2 billion euros in emergency liquidity from the ECB in November, up from 111.3 billion euros at the end of October, Bank of Italy data showed, another big leap in reliance on the central bank which has almost quadrupled since June, when Italian lenders took 41.3 billion euros.
Euro zone banks took more than $50 billion in the ECB's first dollar funding operation since the world's leading central banks agreed last week to cut their cost, five times the $10 billion forecast in a Reuters poll of money market traders.
Germany is set to reactivate its bank rescue fund at next week's cabinet meeting, a senior government official said.
The ECB's governing council holds a crucial meeting on Thursday, before the EU summit, at which most economists expect it to cut interest rates to 1.0 percent from 1.25 percent, introduce longer-term liquidity tenders for banks and widen the collateral they can use to borrow from it.
ECB President Mario Draghi, who met Geithner on Tuesday in Frankfurt, has signaled that a euro zone "fiscal compact" could encourage the ECB to act more forcefully.
FLY ME TO THE GLOOM
Ratings agency Standard & Poor's heightened the sense of crisis this week by warning it could cut credit ratings across the 17-nation currency bloc, including for its EFSF rescue fund, a move that would fundamentally weaken it.
A snap Reuters poll of 13 economists found 11 expect France to lose its top-notch AAA credit rating within three months, a potential blow to Sarkozy's bid for re-election next year.
But growing market optimism that euro zone leaders are on track to produce a confidence-boosting package of measures lifted risk appetite on Wednesday, boosting stocks and the euro. In another positive sign, Italy's borrowing costs continued to tumble.
Two days before the summit, new ideas were surfacing about how to boost the euro zone's crisis capabilities. EU officials said leaders may decide to raise the combined lending limit of the temporary EFSF and its successor, the permanent European Stability Mechanism, which France and Germany want introduced a year early, in 2012.
But the German official said he could not foresee running the two funds simultaneously. He also objected to talk of issuing joint euro zone bonds as a longer-term solution.
Details of the Franco-German reform proposals were due to be presented on Wednesday in a letter to European Council President Herman Van Rompuy, who will chair the meeting of 27 EU leaders.
With much of Europe facing a relapse into recession in the coming months, airlines worldwide face severe losses next year unless Europe's politicians get to grips with the region's debt crisis, the industry's leading trade group warned.
The International Air Transport Association (IATA) shaved its main forecast for industry profits to $3.5 billion for 2012, and said the industry could plunge to an $8.3 billion loss with no region of the world exempt if Europe's debt woes precipitate a new banking crisis.
Geithner later met Sarkozy and was due to fly to the southern French port of Marseille for talks with incoming Spanish prime minister Mariano Rajoy.
The treasury secretary, whose fourth trip to Europe in as many months speaks of the alarm in Washington at the damage the debt crisis could wreak on the U.S. and world economy, said he was encouraged by moves towards tighter budget rules for EU states.
COST TO GERMANY RISING
Van Rompuy has proposed giving the permanent euro zone rescue mechanism the status of a bank that would allow it to access ECB funding, but Germany has opposed the move, saying it would breach a ban on the ECB financing governments.
Another German government source said Germany's net new borrowing could rise beyond the 26.1 billion euros planned for next year if euro zone leaders move forward the permanent European Stability Mechanism to 2012.
Sarkozy and Merkel want treaty changes to be agreed in March and ratified before the end of 2012. If some countries block treaty change for all 27 EU members, the 17 euro states could proceed with an agreement on their own.
Van Rompuy says tighter budget oversight sought by Paris and Berlin for the euro area could be achieved quickly with only minor tweaks to the EU treaty, which might not require full ratification procedures in many countries.
Rajoy said he would support a new treaty. However, some other EU governments, notably Britain,Ireland and the Netherlands, are reluctant to amend the EU charter, either due to eurosceptics at home or because they fear losing possible referendums on ratification. Geithner will travel to Italy late on Wednesday for talks on Thursday with Monti.
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