EURO ZONE leaders were last night under mounting pressure to recapitalise the region’s weakest banks amid warnings from regulators that the problems of the stricken Franco-Belgian lender Dexia could spread to other banks.

As renewed uncertainty over the fate of Greece fanned a collapse in Dexia shares and drove those of other banks sharply lower, EU finance ministers left a meeting in Luxembourg without taking any new initiatives to calm the turmoil on financial markets.

France and Belgium raced to prop up Dexia, pledging emergency action to support it via guarantees for a “bad bank” holding its worst assets.

Dexia’s troubles are seen as a clear sign that the 20-month-long sovereign-debt emergency in the euro zone could yet spark a new banking crisis.

The bank’s weakening position is seen as a sign that the debt crisis may spread further into “core” euro zone countries from “peripheral” countries such as bailout recipients Ireland, Greece and Portugal.

Meanwhile, Moody’s last night cut Italy’s bond ratings by three notches, saying it sees a “material increase” in funding conditions for euro zone countries with high levels of debt.

The ratings agency downgraded Italy’s ratings to A2 from Aa2 and kept a negative outlook on the rating, a sign that further downgrades are possible.

Italy’s prime minister, Silvio Berlusconi, said the downgrade was expected and reiterated that the government was committed to its budget goals. He said its plans, including a target to balance the budget by 2013, had been welcomed and approved by the European Commission.

European leaders have been resisting pressure from the International Monetary Fund and the European Commission to take radical steps to boost the position of the most vulnerable euro zone banks.

However, bank recapitalisations are now seen by some ministers as the highest immediate priority and they are known to have examined further state bailouts at the Luxembourg talks. “Making the banks secure in crisis is the top priority for now,” Austrian minister Maria Fekter said in Luxembourg.

Irish banks are relatively secure in the current turmoil thanks to a big recapitalisation under the EU-IMF bailout last spring.

“I think it’s apparent that some European banks will have to be recapitalised but the initiative has to come from their own governments and their own finance ministers,” said Minister for Finance Michael Noonan.

“We have done our recapitalisation and we have done it very thoroughly and to very strong stress-testing.”

The European Banking Authority, set up last year to intensify pan-European supervision of the financial sector and avert the potential for crises, will discuss the situation in Dexia at a regular meeting today.

“We are in a really dangerous interconnection between sovereigns and the banks,” the authority’s chairman Andrea Enria told MEPs in Brussels. It was crucial to quickly resolve the funding problems in Dexia, as they “could spread to other banks” otherwise, he said.

The latest tumult on markets follows the admission by Greece that it will miss the fiscal targets set out in its EU-IMF bailout, prompting euro zone finance ministers to demand additional austerity measures to make up the slack. This has stoked renewed fear of a sovereign default by Greece, something EU leaders still pledge to avoid.

However, the ministers’ move to examine whether they should seek a bigger contribution to the country’s second bailout from its private creditors amplified tensions yesterday.

The second Greek bailout deal assumes the overwhelming majority of its bondholders will voluntarily bear losses of 21 per cent on their investment, but most analysts believe only a 50 per cent “haircut” would bring Greek debt to a sustainable level.

The Athens Stock Exchange fell to its lowest level since 1993, and European shares fell close to their lowest level for 26 months. The euro hit a nine-month low against the dollar.

French banks are the most heavily exposed to Greek sovereign debt and concern in markets does not stop with Dexia. Shares in the country’s three largest lenders – Crédit Agricole, BNP Paribas and Société Générale – have dropped significantly in recent weeks.