EU leaders met in Brussels to tackle a year-long debt crisis that has consumed Greece and Ireland [Reuters]

European Union leaders have agreed to change the EU treaty to create a permanent financial safety net, a measure designed to fight the euro zone debt crisis.

A two-sentence amendment to the EU's governing treaty was approved at Germany's behest to permit the creation of a European Stability Mechanism (ESM) to handle financial crises from 2013, a draft summit statement said on Thursday.

The ESM, which replaces a temporary European Financial Stability Facility (EFSF) created in May, will be empowered to grant loans on strict conditions to member states in distress, with private sector bondholders sharing the cost of any sovereign debt write-down on a case-by-case basis.

The aim is to have the treaty change ratified by all 27 member states by the end of 2012.

The EU, together with the IMF, has set up a about $993bn emergency loan pool to help highly indebted euro zone states unable to finance themselves in volatile financial markets.

'Ensuring stability'

Herman Van Rompuy, the EU president, said that the heads of state "stand ready to do whatever is required to ensure the stability of the euro zone".

However, he insisted that only about four percent of the bailout fund has been utilised since it was introduced in May, and that the question of expanding it "is not being posed today".

The leaders were holding their seventh summit of the year, a record number due to the debt crisis, in which Greece and Ireland have received EU/IMF bailouts and Portugal and Spain are seen by markets as potential risks.

In a separate move on Thursday, the European Central Bank, in charge of monetary policy in the 16-nation euro area, said it would almost double its capital to about $14.24bn to cope with bigger credit risk and market volatility. Euro zone members will provide the increase.

The decision by the Frankfurt-based ECB to raise its subscribed capital base was the first such increase in its 12-year lifetime, a mark of the severity of the situation.

"We infer from this that the ECB ... is seeking a greater cushion in order to offset potential losses, given that its portfolio of securities holdings has risen substantially, as well as to protect itself from potential collateral losses," Barclays Capital economists said in a research note.

The central bank has bought some $95bn in euro zone government bonds since May but has resisted political pressure to substantially step up these asset purchases to help indebted governments avoid having to seek a bailout.

'Piecemeal approach'

Dominique Strauss-Kahn, the managing director of the International Monetary Fund, who has been critical of EU leaders' disjointed response to the rolling crisis, said he was worried about slow growth and the threat of contagion in Europe.

"… I'm urging the Europeans to provide for a comprehensive solution, because this piecemeal approach obviously doesn't work," Strauss-Kahn told a Thomson Reuters Newsmaker event in Washington. "And the markets are just waiting for what's next."

Credit ratings agency Moody's highlighted investor fears about the first country to receive an EU/IMF rescue by saying it was putting Greece under review for a possible downgrade, due to uncertainty over its ability to cut debt to a sustainable level.

Strauss-Kahn said he was concerned about the length of the process Europe was going through to resolve its crisis and said the EU needed to find a "comprehensive" solution.

But he voiced optimism that Spain would be able to ward off the worst of the debt crisis without needing a rescue, and said he saw no threat to the euro's existence.

Angela Merkel, the German Chancellor, who pressed for the treaty change to assuage Germany's constitutional court, sought to keep other ideas, such as increasing the size of the EFSF or issuing euro zone bonds, off the summit agenda.

Source: Agencies