European leaders step up to the plate with scheme to keep infection from spreading

Leadership is what the markets craved; and it now seems the world's leaders have finally stepped up to the plate. Reports that European officials are working on a plan to keep the single currency project afloat by preparing for an orderly default of Greece is what the markets have been begging for, for months, to restore confidence – and stop the world from plunging into recession again.

But what we don't know yet is whether this plan, which means some of Europe's biggest banks facing huge losses on their exposures to Greece's debt, will lance the boil for good. As it stands, the plan being put together by the German and French authorities is to create a sort of shield around Greece, as well as Portugal and Ireland, to stop the infection reaching Italy and Spain; if they went down it would surely pull the euro apart. The Franco-German plan proposes that half of Greece's debt will be wiped out, which means that French and German banks will have to take a loss of 50 per cent of their loans.

French banks have lent about €9bn to Greece, while those in Angela Merkel's Germany have €10bn in Greek sovereign debt. These already stretched banks may then have to go themselves to investors – private and public – for more capital, or to their own governments. Banks such as BNP Paribas and Société Générale have billions in loans extended not just to Greece, but to Italy and Spain too.

From what we can gather, the new "recapitalisation" plan would go much further than the €2.5bn already demanded by regulators following the European bank stress tests in July. Most importantly of all, for the first time it acknowledges that the French banks will have to take a hit. According to sources in Washington, officials and politicians are confident that if Europe's banks – by which they mean the French – can't get new funds privately they will be able to go to their government, or the European Financial Stability Facility (EFSF) – the eurozone's €440bn emergency bailout scheme.

That means more money will have to be put into the EFSF, and some economists reckon it will need about €2 trillion to keep Italy and Spain afloat if they can't get credit in the markets. That's why Europe's officials are working on ways to leverage up the EFSF – through the European Central Bank – to get the ammunition it needs.