European leaders on Thursday have approved a new rescue package for Greece that could place the country’s debt into selective default for a short period but would also extend the powers of eurozone’s bailout fund in reviving struggling economies.

German Chancellor Angela Merkel told reporters in a press conference after an earlier meeting of 17 heads of state of the eurozone that a bailout package amounting to 109 billion euros for Greece has been approved. She said the banks will take part in some of the debt reducing programs indicated in the draft statement such as bond swap involving debt paper with much lower interest rates and has longer maturities.

On extending the debt repayment structure, credit rating agencies have warned that such measures could potentially lead limited default on some of the country’s debt since creditors are likely not to be fully repaid according to the original loan terms.

Earlier, leaders of eurozone’s two biggest economies –Germany and France – have both agreed that a second bailout plan for Greece is necessary and must be passed during the summit on Thursday whose objective is prevent the country’s fiscal problems from spreading across Europe. An official statement released by the office of French President Sarkozy that he and Merkel have booth reached an agreement after a 7-hour marathon discussion in Berlin.

Top European leaders have scrambled to find a solution to yet another looming debt crisis in Greece as there are signs that the contagion is now spreading beyond its borders. There was previous speculation that new taxation for European banks to fund the financial aid to Greece would not be considered.

On the eve of the summit, sources have hinted that the second Greek financial rescue effort may involve a buyback as it is one of primary options being considered. A buyback of the Greek debt paper means that the private sector will be involved in the bailout. While Germany has espoused a non-spectacular measure to address the crisis, France, on the other hand, wanted a stronger, long-term solution to the Greek problem to be approved in the Brussels summit on Thursday.

The stakes were definitely high as it has caused the markets to be extremely volatile in the previous weeks on worries that Greece’s debt crisis could spread to larger economies like Italy. The IMF have issued a strong warning that European leaders must act swiftly to stop a possible contagion from spreading all over the continent.

Before the consensus was reached, there were still some disagreements on the aspect of private sector involvement to the Greek rescue package. Germany had earlier wanted that private creditors should bear some losses while this has been opposed by France and the ECB for fears that it might lead to a banking crisis throughout Europe, making economies like Spain and Italy more vulnerable, and even putting the solvency of the ECB at risk.

Also, the leaders were urged to give sweeping new powers to the European Financial Stability Facility (EFSF) by allowing it to buy back government debt on the secondary market and shore up the banks’ financial standing. According to the statement in the proposed draft, the EFSF will have the ability to help countries that have not even asked for a bailout. Just months ago, Germany strongly rejected this idea. The EFSF is a special purpose vehicle created by member states of the EU in May 2010, which aims to preserve European financial stability by giving financial assistance to states experiencing economic difficulty such as Ireland, Portugal, and Greece in the past.