The euro-zone nations have reached a deal to build up a massive 800-billion-euro (around $1.1 trillion) financial firewall to prevent the two-year-old sovereign debt crisis from engulfing larger economies such as Spain and Italy.
The finance ministers of the 17 nations using the single currency agreed yesterday at the start of a two-day meeting in Copenhagen to bolster the firepower of euro-zone's financial bailout fund to 700 billion euros.
It will be done by bringing together the temporary European Financial Stability Facility (EFSF) and the permanent fund European Stability Mechanism (ESM), which has an initial funding capacity of 500 billion euros.
ESM, which was intended to replace the EFSF in June, next year, has been brought forward a year earlier and it will run side-by-side with the EFSF for a limited period.
The ministers decided to add to ESM around 200 billion euros pledged for Ireland, Portugal and Greece from the EFSF.
Around 53 billion euros disbursed so far from the first bailout package of 109 million euros offered for Greece by the EU in May, 2010 and 49 billion euros from the European Commission's aid programme will make up the rest of the expanded financial safety net.
They also agreed to keep around 240 billion euros left unutilised in the EFSF as 'reserve' until mid-2013.
It will not be added to boost the size of the new bailout fund to 940 billion euros as demanded by European Commission, some member nations as well as by the Organisation for the Economic Cooperation and Development (OECD), the ministers said. However, this resource will be tapped if the ESM's funding capacity will not be sufficient to cope with a new crisis, they said.
The euro-zone nations are hoping that the massive financial firewall will act as a deterrent against attacks by speculative investors in the financial markets on heavily-indebted nations such as Spain or Italy and thereby drive up their borrowing costs.
Greece, Ireland and Portugal had to be rescued by EU and IMF after their borrowing costs reached unaffordable levels.
The euro zone also has been under pressure from the International Monetary Fund (IMF) and the G-20 nations to deal with its debt crisis effectively by substantially boosting its bailout fund.
The euro group took "a significant decision to reinforce the euro area financial firewalls by raising the combined ceiling for the ESM and ESF to 700 billion euros", European Commissioner for Economic and Monetary Affairs Olli Rehn said in a press statement.
"All together, the euro area is mobilising an overall firewall of 800 billion euros, more than $1 trillion," Rehn said.
He expressed optimism that the euro group decision would "reinforce the confidence" in the European economy among its international partners and the financial markets and would pave the way for an increase in the IMF's resources at next month's meeting of the international lender.
German finance minister Wolfgang Schaeuble said he hoped the decision to boost the bailout fund would convince the financial markets.
"The financial markets want to know whether Europe is in a position to create the structures necessary to ensure long-term stability of our common currency and investments in this region. There we have made great progress," he told reporters after the meeting.
French finance minister Francois Baroin, who on the eve of the Copenhagen meeting demanded a firewall of at least 1 trillion euros, expressed satisfaction over the agreement reached.
It is a "strong signal" to the financial markets that the euro-zone nations are determined to defend their common currency, he said.
Friday's agreement among the euro-zone finance ministers after months of wrangling became possible after Germany, the largest contributor to the bailout fund, earlier this week dropped its objection to a bigger firewall and allowed the EFSF and the ESM to operate side-by-side for a limited period.
Germany also gave up its demand to deduct from the ESM around 200 billion euros given from the EFSF to bailout Ireland at the end of 2010 and Portugal in early 2011.
Germany accepted the proposals by its partners to keep around 240 billion euros left in the EFSF as a "buffer" until June, next year.
German finance ministry in Berlin estimated that by putting together the ESM and the ESF for a limited period, Germany's share of credit guarantees for the bailout fund will go up to 420 billion euros from 211 billion euros approved by parliament for the EFSF.
The German government is facing strong public criticism for giving in to the international pressure to expand the bailout fund.
It has maintained, however, that the expanded financial firewall for the euro zone did not represent any real increase in the funding capacity which has been boosted by putting together the ESM and the EFSF and by adding aid funds already committed for Ireland, Portugal and Greece.
The EFSF was set up in June, 2010 with a lending capacity of 440 billion euros and it supported the bailouts of Ireland and Portugal and part of the second bailout of Greece.