With time fast running out, German chancellor Angela Merkel and French president Nicolas Sarkozy again held emergency talks overnight in an attempt to settle their differences before Sunday’s crucial summit of European political chiefs.

The stakes are extremely high. Financial markets took Merkel and Sarkozy at their word almost a fortnight ago when the two pledged they would come up with a comprehensive plan for stemming Europe’s worsening bank and debt crisis by the end of the month.

At this point, Merkel and Sarkozy have relinquished all hope of coming up with a grand plan for solving the crisis. They’re just hoping they can do enough to avoid a major financial market meltdown.

But the two sides remain deeply divided over the size of the Greek debt restructuring, and the firepower that the eurozone’s €440 billion ($US605.3 billion) bailout fund. Berlin opposes increasing the level of guarantees that France and Germany provide for the fund, arguing that this could see France lose its precious triple-A rating. Not surprisingly, Paris agrees with this, but wants to transform the institution into a bank, which will be able to raise funding from the European Central Bank.

Overnight, French finance minister François Baroin signalled that Paris still believed this was still “the most effective solution”.

But ECB boss Jean-Claude Trichet is backing Germany’s Merkel on this one, and both have come out strongly against France’s preferred solution.

As a result, Paris has indicated that its prepared to support an approach that would boost firepower of the bailout fund by allowing it to insure private sector investors against the first 20-30% of losses they suffered if they purchase the bonds of troubled eurozone countries. Some calculate that this could boost the firepower of the bailout fund to €2 trillion, although Berlin, which is always somewhat fearful when it comes to debt, wants the fund’s firepower to be limited to a more modest €1 trillion.

Paris and Berlin are also at odds when it comes to the restructuring of Greece’s huge mountain of debt. Berlin wants public sector creditors — such as banks, insurance companies and pension funds — to agree to write-down 50% of their debts.

But Paris is deeply worried that such a hefty write-down could cause markets to call an event of default on Greek debt, which could trigger a financial melt-down similar to that which followed Lehman’s collapse. As a result, Sarkozy — this time backed by the ECB’s Trichet — is pushing for a lower level of write-offs.

Still, Paris and Berlin appear to have made some progress when it comes to dealing with the eurozone’s banking crisis. It now appears that banks will be required to lift their core tier-one ratio to 9% by July next year. What’s more, Paris appears to have given up its demand that the eurozone rescue fund help recapitalise the region’s banks.

Instead, it will be left to the region’s banks to meet the higher capital standards by shrinking their balance sheets, and by cutting back on the dividends and bonuses they pay, and the eurozone rescue fund will only be able to inject capital into banks in countries such as Greece or Portugal which have already received a bailout.

Meanwhile, the embattled Greek government pushed ahead with its latest round of austerity measures overnight, despite massive protests by more than 100,000 striking workers, students and business owners. Banks, shops, cafés and supermarkets, government offices, museums, ancient sites, schools and courts were all closed overnight, as part of a 48-hour general strike.

But even though the Greek economy is in its fourth year of recession, and the youth unemployment rate has climbed above 40%, Greece’s Socialist government has little choice but to enact unpopular austerity measures if it wants to receive the next €8 billion instalment from its bailout package. Without it, the government has said it will run out of money by mid-November.

*This article first appeared on Business Spectator