European leaders reach key deal on banks

(CNN) -- European leaders reached a "breakthrough" deal early Friday to ease the recapitalization of struggling banks that should help draw the eurozone back from the brink of a gathering crisis.

Under the deal, European leaders agreed to create a single supervisory body to oversee the eurozone's banks which could use the single currency area's rescue funds, the European Financial Stability Facility or European Stability Mechanism, to aid banks directly without adding to governments' debt.

European Union leaders are hoping for implementation of the agreement by July 9, an EU statement said.

The deal means Spain's formal request this week for eurozone bailout funds to recapitalize its troubled banking sector will not add to its sovereign debt. Madrid had feared the increased debt load would send its borrowing costs even higher.

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Ireland, which hopes to rework the terms of its bailout deal, and Italy, which like Spain is battling with spiraling government borrowing costs, could also benefit from the new deal.

European Council President Herman van Rompuy announced the agreement, seen as a concession by German Chancellor Angela Merkel, after a marathon late-night meeting in Brussels, Belgium.

"We agreed on something new, which is a breakthrough, that the banks can be recapitalized directly in certain circumstances," he said.

"The most important condition is that we have to put in place a single supervisory mechanism and second decision is that we are opening the possibilities to countries who are well behaving ... to make use of financial stability instruments ESFS, ESM in order to reassure markets."

The deal is a big step toward a closer banking union across the 17-nation eurozone, which could be seen as a precursor to fiscal union.

European markets responded positively to the news Friday morning and the euro currency strengthened appreciably.

"It is imperative to break the vicious cycle between banks and sovereigns," the eurozone leaders said in a statement.

Their proposals should be considered "as a matter of urgency" before the end of the year, the statement said.

The single supervisory mechanism would be in "compliance with state aid rules, which should be institution specific, sector-specific or economy-wide and would be formalized in a Memorandum of Understanding."

EU Commission President Jose Manuel Barroso said it was a "very ambitious decision that shows, once again, the commitment of the member states, namely those in euro area, to the irreversibility of the euro, and I think this will be recognized by all."

Irish Prime Minister Enda Kenny welcomed the new deal, saying Ireland's bailout debt could be "re-engineered," reducing the burden on taxpayers.

He said the agreement represented a "seismic shift" in EU policy.

The establishment of a single supervisory body should mean that recapitalization rules are better enforced across the eurozone, helping to restore investor confidence and stability.

This may reassure Germany, which had been opposed to the introduction of new short-term rescue measures.

The agreement also states that financial support to Spain's banks will be funded by the EFSF until the new bailout fund, the ESM, comes on line next month. It will then be transferred to the ESM but official lenders won't have "seniority" status, which would have put them ahead of private sector creditors.

French President Francois Hollande said the meeting of the 17 eurozone heads of state, held after the leaders of the EU countries outside the single currency area had left, was the result of pressure from Spain and Italy quickly to find short-term measures to stabilize the markets.

The euro has been badly shaken by more than two years of constant crisis, which in turn has sent reverberations through global markets.

CNN's Pierre Meilhan, Laura Smith-Spark, Kendra Wates and journalist Peter Taggart contributed to this report