Spain overhauled its banks for the fifth time in three years on Friday in order to secure up to 100 billion euros ($125 billion) in European aid, and injected emergency funds into its biggest problem bank, Bankia.
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Spain's banks are saddled with 184 billion euros in bad loans and repossessed buildings four years into a property market crash and are in urgent need of rescue because most are cut off from funding other than from the European Central Bank.
The government created a so-called bad bank to take over tens of billions of euros in defaulted loans and unsaleable property to meet the conditions of the European rescue of the financial sector, Economy Minister Luis de Guindos said.
Spanish banks' difficulties are at the heart of the euro zone debt crisis, but the rescue has not cleared up doubts about the sector and Spain is under pressure to ask for a full sovereign bailout like Greece or Portugal.
The bad bank will begin operating in late November or early December and will exist for between 10 and 15 years, during which time it is intended to be profitable so that Spanish taxpayers do not bear the burden of the bank rescue operation.
"The prices of these assets (that banks transfer to the bad bank) must ensure that the entity does not generate losses during its lifetime, something that is very important to minimize the impact on taxpayers," de Guindos told a news conference.
De Guindos also announced new rules for swift government takeovers of problem banks, a cut in pay for executives at banks that have been rescued by the state, and rules that will stop banks selling complex securities to unsophisticated investors.
Spain asked for a European rescue for its banks in June after it took over Bankia, a large lender that was particularly exposed to the property market.
Bankia, which lost 3 billion euros last year, on Friday reported a further 4.4 billion euros of losses in the first half of this year.
Shortly afterwards, the government's bank restructuring fund, or FROB, said it would immediately inject emergency capital into Bankia, as an advance on the European rescue money due later this year. The FROB, which has about 4 billion euros in its coffers, did not say how much it would put into Bankia.
SPAIN UNDER PRESSURE
Despite the aid for the banks and an aggressive government drive to cut the public deficit, Spain's borrowing costs remain painfully high. The economy is contracting and a quarter of workers are jobless, which means tax revenue is falling and this is undercutting the austerity drive.
The bad bank announcement came on the heels of data that showed investor confidence in Spain eroded in the first half of the year with 316 billion of euros of net capital outflow, up almost 70 percent in the last six months.
Spanish stocks rose after the bad bank news but bond prices slipped a little. The IBEX blue-chip index extended gains to just over 3 percent in afternoon trade while the yield on Spain's benchmark 10-year bond rose to 6.76 percent from 6.73.
Spain has pushed its banks through several rounds of consolidation and recapitalisation, then this year they were also forced to recognise huge losses on real estate assets.
The bad bank takes the reform even deeper. Private investors in rescued banks will bear some of the cost of the clean-up. Holders of complex instruments known as preference shares will take a major hit, as the prices for those securities have fallen steeply.
Countries such as Sweden and Ireland have used bad bank structures to rescue their financial sectors, but the Spanish version is not modelled on any specific predecessor.
At least four Spanish banks, Bankia and three others already under government control, are set to receive aid money under the rescue measures.
A number of other banks are also expected to need aid, though they will not be named until late September, after an independent audit by the big-four global accounting companies.
Banks will receive cash, government bonds or a stake in the bad bank in return for assets they transfer to the new entity, formally called an asset management company.
"The law provides the necessary legal basis to effectively carry out a comprehensive restructuring of those Spanish financial institutions that are in need of external support," EU Economic and Monetary Affairs Commissioner Olli Rehn said.
The bad bank will be financed by European rescue funds that will be channelled through the FROB, private investors, and debt it raises in the market, de Guindos said.
The amount of European rescue money that will go into the bad bank is low, de Guindos said.
The Bank of Spain will determine prices for assets transferred to the bad bank. While they cannot be so low that they cripple already weak banks, they must be low enough so they can be sold at a profit at some point in the future.