10/12/2011 07:06 EDT | Updated 12/12/2011 05:12 EST

EU raises stakes in fight against crisis, setting out plans for banks, Greece, bailout fund

BRUSSELS - Europe's biggest banks must raise billions of euros in capital to better withstand market turmoil, the European Commission proposed Wednesday, as it embarked on a major push to contain the continent's escalating debt troubles and avert a second recession.

The fear gripping the financial sector is that banks may soon have to take big losses on bonds they own from governments with shaky finances, like Greece. That uncertainty is stifling lending — both between banks and to the wider economy — threatening to kill off a halting recovery in the 17-nation eurozone and much of the rest of the world.

The Commission, the EU's executive body, believes that boosting confidence in Europe's financial sector is a crucial step that will allow the continent's leaders to tackle Greece's massive debts and stop the debt crisis from spinning out of control. The commission also is trying hard to protect large, troubled economies like Italy and Spain, which are too big to be bailed out, from being dragged into the debt crisis.

Wednesday's proposals, presented by Commission President Jose Manuel Barroso, foresee that key lenders in Europe will have to implement new international rules on bank capital much earlier than 2019, as was initially planned.

Barroso also warned that banks should not be allowed to pay out dividends or bonuses until they have raised their capital buffers to the new standards.

Under the so-called Basel III rules, the continent's biggest banks have to bolster the financial pad they maintain to absorb losses to about 9 per cent of their loans, investments and other risky assets, compared with the 5 per cent to 6 per cent they needed to pass this summer's stress tests. Many experts have criticized those stress tests as way too lenient.

Barroso did not say when the new capital levels would have to be reached, but a person familiar with the matter said it would happen "substantially earlier" than 2019. The person spoke on condition of anonymity because the European Banking Authority won't disclose the new standards until next week.

Barroso presented the proposals on bank capital as part of a broader plan to tackle the currency union's debt troubles, which have dragged on for close to two years.

He also lobbied for continued support for Greece, a more effective use of the eurozone's bailout fund, and bigger powers for the Commission to control national budgets.

The EU's executive hopes the leaders of the 27-nation bloc will embrace its suggestions at a crucial summit on Oct. 23 — which officials believe may be their last chance to solve the debt crisis before it really explodes. By revealing its plans ahead of that meeting, the Commission sought to pile more pressure on national governments, which have often moved slowly on more radical action.

Banks immediately came out against the proposed acceleration of Basel III.

"The banking federation considers these proposals unsuitable, because they don't attack the origins of the current sovereign debt crisis," said Michael Kemmer, head of the German banking federation said.

Banks around the world have lobbied hard against stricter regulation on capital buffers, warning that it would force them to restrict lending to businesses and limit other key activities.

But banking shares and the euro continued to surge after Barroso's proposals, continuing a weeklong rally triggered by hopes that the eurozone may finally get a grip on its worsening debt crisis.

To assess banks' capital needs, Barroso said their exposure to all sovereign debt should be taken into account "in a transparent way." The Commission asked for a "prudent valuation of all sovereign debt, whether in the banking book or the trading book" of banks.

That's an important change from July's stress tests, when banks had to take writedowns only on bonds in their trading books, where they hold assets they could sell at any time.

Lenders did not have to prove they have enough capital to also absorb potential losses on bonds they plan to hold until they mature.

Barroso said if banks can't raise the necessary capital on the market, they should get help from governments, which in turn can ask for money from the eurozone bailout fund.