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With the turmoil threatening to spiral into financial meltdown as the value of banks' sovereign bond holdings slide, Merkel and Sarkozy are likely to discuss in Berlin both how to manage Greece, prevent contagion and strengthen lenders.

The implosion of Belgian lender Dexia, the first victim of the crisis, has added a sense of urgency to the talks.

"Dexia will be among the topics that will be discussed but the main topic is Greece and the euro zone, as banks are only a consequence" of the crisis, a source at the French finance ministry told Reuters.

Sarkozy is due to arrive in Berlin late Sunday afternoon and hold a meeting with Merkel followed by a working dinner.

Talks are continuing over a vital aid tranche for Greece, which could run out of cash as soon as mid-November.

"There is a high risk that this crisis further escalates and broadens," German Finance Minister Wolfgang Schaeuble was cited as saying by a newspaper Sunday.

BOLSTERING BANKS

Germany and France have so far been split over how to recapitalise Europe's banks, which Ireland estimated Saturday may need more than 100 billion euros ($135 billion) to withstand the sovereign debt crisis, while the International Monetary Fund (IMF) has said the banks need 200 billion in additional funds.

Paris wants to tap the euro zone's 440 billion European Financial Stability Facility (EFSF) to recapitalise its own banks, while Berlin is insisting the fund should be used as a last resort.

Another key dispute is how to use the EFSF to buy sovereign debt to prevent contagion of the crisis, particularly crucial if Greece fails to secure its next aid tranche.

France does not want to set guidelines for the EFSF on the matter, whereas Germany wants to limit the sum used for each member state and set a time limit for bond purchasing, Handelsblatt reported.

"Given that the EFSF is limited overall, it makes sense also to limit the purchases on the secondary market for each country," Michael Meister, deputy parliamentary leader of Merkel's conservatives, told Reuters Saturday.

There was a danger, otherwise, the funds could be quickly used up, he said.

The two euro zone heavyweights have come under pressure worldwide to resolve Europe's crisis which is roiling markets. U.S. President Barack Obama Thursday urged Europe to "act fast," calling the common currency bloc's crisis the largest obstacle to the United States' own recovery.

World Bank President Robert Zoellick told Wirtschaftswoche magazine there was a "total lack" of vision in Europe and Germany in particular needed to show more leadership.

Merkel will visit Vietnam and Mongolia this coming week.

(Additional reporting by Yann Le Guernigou; Editing by Louise Ireland)

Dexia, whose board was also due to meet Sunday, was forced to seek government help this week after a liquidity crunch hobbled the lender and sent its shares into a tailspin.

Belgian caretaker Prime Minister Yves Leterme told a news conference Saturday evening that final negotiations between France and Belgium would take place in Brussels Sunday.

Finance Minister Didier Reynders said Belgium had been in touch with France, Luxembourg and the European Commission.

"I hope tomorrow we will reach our goals," he said.

The Franco-Belgian bank's near collapse stoked investors' anxieties about the strength of European banks and coincided with growing talk about coordinated EU action to recapitalise banks across the continent.

The burden of bailing out Dexia led ratings agency Moody's to warn Belgium late Friday that its Aa1 government bond ratings may fall.

Some investors view the response to Dexia's woes as a test of European governments' ability to take decisive action to rescue banks if the euro zone debt crisis worsens.

French President Nicolas Sarkozy was due to meet German Chancellor Angela Merkel Sunday in Berlin to thrash out differences on how to use the euro zone's financial firepower to salve a sovereign debt crisis that threatens the global economy.

Dexia's overhaul will see its French municipal financing arm split from the group and merged with French state bank Caisse des Depots and Banque Postale, the post office's banking arm.

The Belgian government wants to nationalise Dexia's largely retail banking business in Belgium.

Healthy units, such as Denizbank in Turkey, will be sold.

A 'bad bank' supported by state guarantees will hold 95 billion euros in bonds, including 12 billion euros of sovereign debt of weaker euro zone periphery nations.

Including 7 billion euros of securities linked to U.S. mortgages, France and Belgium may need to provide guarantees to cover up to 200 billion euros of assets, which would be more than 55 percent of Belgian GDP.

The key issues for Sunday's talks will be how to divide up the 'bad bank' assets, how much Belgium should pay to nationalise Dexia's Belgian banking business and whether others, such as Belgium's regions, would be involved in its purchase.

Dexia's shares have been suspended since Thursday afternoon and have lost 42 percent since last Friday.

(Editing by Louise Ireland)

The falling value of banks' holdings of government debt from Greece and other euro zone periphery states has already provoked the implosion of Belgian lender Dexia, adding urgency to the Merkel-Sarkozy talks.

"There is a high risk that this crisis further escalates and broadens," German Finance Minister Wolfgang Schaeuble told German paper Frankfurter Allgemeine Sonntagszeitung in an interview released in advance of publication on Sunday.

Germany and France have so far been split over how to strengthen shaky lenders and fight financial market contagion that may follow a possible Greek default.

Paris is keen to tap the euro zone's 400 billion rescue fund, the EFSF, to recapitalize its own banks, while Berlin is insisting the fund should be used as a last resort.

The International Monetary Fund (IMF) has said European banks need 200 billion euros in additional funds.

Irish Finance Minister Michael Noonan said the capital needed to bolster banks' cushions was likely to come from a variety of sources but the total bill would be large.

"I think there is general agreement that it will be significantly in excess of 100 billion (euros)," Noonan told reporters on the sidelines of an economic forum in Dublin.

"I know that some of the big German banks that I was talking to personally intend raising money on the market so it will be private funding. Other banks would like to avail of the EFSF fund. Other banks will rely on their sovereign governments to provide the capital so there is going to be a range of ways of doing it," he said.

Regulators worry that forcing a raft of major lenders to take state aid would not be the best use of Europe's limited capital resources, while banks fear than singling out only some lenders for extra support could heighten market worries about weaknesses at individual banks.

German newspaper Frankfurter Allgemeine Zeitung on Saturday cited financial sources as saying France's five-biggest lenders would agree to take 10-15 billion euros in funding from the state but also wanted to see Germany's No. 1 lender Deutsche Bank plump its capital cushion.

But a senior French banking source shot down the idea that French banks could be pushing for state aid, saying the Frankfurter Allgemeine Zeitung report was baseless.

"I don't know what game the Germans are playing... This is wishful thinking," the source told Reuters, asking not to be named.

Deutsche Bank Chief Executive Josef Ackermann is against any role for the state in his own bank's capital position and has ruled out a capital increase.

A Deutsche Bank spokesman on Saturday referred to Ackermann's long-standing public position and declined further comment.

The chief financial officer of Deutsche Bank unit, Deutsche Postbank, said he expected the 21 percent haircut on Greek bonds that international banks agreed to take as part of a EU-brokered debt relief deal in July would not be enough.

"Therefore we would expect renewed writedowns in the third quarter," Postbank's Marc Hess told Boersen-Zeitung newspaper.

Banks' need to gird their capital bases is also leading some to merge, such as Spain's No. 5 retail bank Banco Popular, which launched an all-share bid for its smaller rival Banco Pastor on Friday.

FIGHTING FIRES

Sarkozy is due to arrive in Berlin on Sunday afternoon and hold a working dinner with Merkel in the evening, amid signs that conditions for resolving the crisis are getting no easier.

Slovakia's coalition government was in deadlock on Saturday over talks on ratifying a strengthening of the EFSF rescue fund, with a junior party insisting on conditions for its support.

Euro zone minnows Slovakia and Malta are the last countries holding up expansion of the EFSF mandate, which is needed to fight the sovereign debt crisis [ID:nL5E7L806G]

Angry Greeks have taken to the streets to protest government efforts to slash spending, boost taxes and privatize state companies but Belgian Finance Minister Didier Reynders said the pain could not go on indefinitely.

"This is not acceptable on a political, social or even economic level: we do not want the cure to kill Greece," Reynders told Greek newspaper Proto Thema in an interview.

Meanwhile, Greece's representative at the IMF said the country's borrowing needs will be higher than currently projected due to a tougher-than-expected recession and the outcome of a debt agreement with private sector creditors.

"This financing gap will have to be covered either by increasing the 109 billion euro loan agreed on July 21 or through a restructuring of private debt," Panagiotis Roumeliotis said in an interview in financial daily Imerisia.

EU leaders agreed in July to provide Greece with a second bailout of more than 109 billion euros to help the country service its debt through to 2020. ($1 = 0.741 Euros)

(Reporting by Jonathan Gould, Sarah Marsh, Carmel Crimmins, Lorraine Turner, Christian Plumb, Philip Blenkinsop, Andreas Rinke and Harry Papachristou; Editing by Alison Birrane)