Europe hastens to build up debt crisis defenses

(Reuters) - European policymakers are quickening their preparations to cope with an escalation of the region's debt crisis as talk of a possible Greek default gained pace on Friday.

Finance chiefs from around the world have turned up the heat on Europe to do more to prevent Greece's debt woes from infecting other euro zone countries and the world economy.

Concern now appeared to be turning toward safeguarding the banking system more than rescuing Greece, as international lenders were increasingly losing patience with Athens consistently missing fiscal and reform targets.

British finance minister George Osborne said the euro zone needed to gain control of the situation by the time leaders of the Group of 20 economies meet in France in November.

"They have six weeks to resolve this crisis," he said on the sidelines of semiannual policy discussions in Washington.

World stock markets, which had plunged to a 14-month low on fears about the scale of the crisis, steadied after European Central Bank officials said they would use more firepower to help the banking system withstand financial strains.

Pressure is growing on European governments for a recapitalization of the region's banks to strengthen them in the event of a Greek default.

At the same time, European policy-makers seemed to be warming to the idea of giving more muscle to their bailout fund, which would be sorely tested if Athens defaulted.

Greek Finance Minister Evangelos Venizelos was quoted by two newspapers as saying an orderly default with a 50 percent haircut for bondholders was one way to resolve the heavily indebted euro zone nation's cash crunch.

Greece is in tense talks with the International Monetary Fund and European authorities, known as the troika, to secure a new 8 billion-euro installment of its rescue package to avoid bankruptcy in October.

In return for aid, Athens pledged austerity measures, but negotiators have expressed frustration at what they say is Greece's slow reform pace. The nation's finance minister is due to meet the head of the IMF on Sunday.

"The troika officials said they were going over again measures they had agreed to months before. They said they had a sense of deja vu," a source close to the talks said on condition of anonymity.

October's loan payment, however, is still widely expected to be made. The next installment is due in December.

ECB President Jean-Claude Trichet urged authorities to take decisive action, saying risks to the financial system had "increased considerably."

Lawrence Summers, a former U.S. treasury secretary, gave a somber assessment of the dangers facing the world economy, including a U.S. recovery that has neared a standstill.

"This is the 20th annual meeting (of the IMF and World Bank) I've been privileged to attend. There has not been a prior meeting at which matters have had more gravity and at which I have been more concerned about the future of the global economy," Summers told a discussion panel.

PUZZLE PIECES

As European policymakers looked to piece together a bolder crisis-fighting strategy, investors took some relief as three officials said the ECB could revive its one-year liquidity lines to shore up banks.

"I think it might be advisable to think about reintroducing this approach," ECB governing council member Ewald Nowotny said.

The IMF, which has been pressing aggressively for a recapitalization of Europe's banks, reckons the debt crisis has increased their risk exposure by 300 billion euros.

In a sign Europe was coming to terms with the idea of a recapitalization, France's top market regulator said 15 to 20 banks needed extra capital.

The growing talk of a Greek default met with stiff opposition from German Chancellor Angela Merkel. She told a meeting of her political party members that default was not an option because it might trigger a domino effect with other struggling economies. "The damage would be impossible to predict," Merkel warned.

Politicians in northern Europe, especially in Germany, have opposed dedicating more money to fight a crisis that they see as caused by the profligacy of other euro zone members. Now, leaders will have to navigate the tricky politics.

"It's not a question of ability for the euro zone," Bank of Canada Governor Mark Carney. "It is a question of political will."

ECB governing council member Klaas Knot told a Dutch daily a Greek default could no longer be ruled out, a warning echoed by the IMF's top official in Europe, Antonio Borges.

"If the Greeks do what they have to do there will be no default," Borges said. "But on the other hand if they hesitate, procrastinate, find it impossible ... then it is very hard to avoid."

G20 finance ministers and central bankers had pledged on Thursday to "take all necessary actions to preserve the stability of the banking system and financial markets as required," a statement that failed to placate investors.

The G20 communique said the 17-nation euro zone would implement actions to "maximize" the impact of the region's bailout fund by mid-October.

G20 participants did not say how the 440 billion-euro European Financial Stability Facility might be altered although French Finance Minister Francois Baroin used the word "leverage" in comments to reporters.

The United States has called on Europe to leverage up the EFSF to give it more firepower.

(Additional reporting by IMF reporting team in Washington, Sakari Suoninen in Frankfurt, Natsuko Waki and Ana Nicolai da Costa in London, Lefteris Papadimas and Ingrid Melander in Athens; Writing by William Schomberg, Glenn Somerville and Paul Taylor; Editing by Chizu Nomiyama and Neil Stempleman)