Spain's four nationalized banks will more than halve their balance sheets in five years, cut jobs and impose losses on bondholders in order to receive a euro zone rescue package.
The measures are a condition of 40 billion euros ($52 billion) in aid that offers hope for an end to a banking crisis which has pushed Spain to the brink of a sovereign bailout to keep the government afloat.
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The European Commission approved the plans on Wednesday, setting in motion one of the most far-reaching overhauls of any European banking system since the start of a banking crisis in mid-2007 with the near collapse of German lender IKB.
"Our objective is to restore the viability of banks receiving aid so that they are able to function without public support in the future," said European Union Competition Commissioner Joaquin Almunia said.
Bankia, NovaGalicia Banco, also known as NCG Banco, Catalunya Banc, and Banco de Valencia were taken over by the state after unsustainable lending during a decade-long property boom left them dangerously short of capital.
The four banks account for just under a fifth of Spain's banking system. They must transfer 45 billion euros of soured property assets to a so-called 'bad bank' as another condition of receiving aid.
The smallest of the four banks, Banco de Valencia, will be sold to one of Spain's healthiest lenders Caixabank, while the other three banks must cut their balance sheets by more than 60 percent over the next five years.
It was cheaper to sell Banco de Valencia under a loss protection scheme than to wind it down, the Commission said. Spain has agreed to sell Novagalicia Banco and Catalunya Banc within 5 years or liquidate them, Almunia said.
The nationalized banks will have to close up to half their branches during the five-year overhaul process, resulting in thousands more job losses in a brutal recession which has pushed Spain's unemployment up to 25 percent.
The biggest of the banks, Bankia, said it would lay off over a quarter of its workforce amounting to over 6,000 staff, and reduce its branch network by around 39 percent as part of plans to return to profitability by 2013.
"Our clients can be totally reassured because we have a viable and solid business in which they can be absolutely sure of their savings," said Chairman Jose Ignacio Goirigolzarri.
Bankia, formed from the merger of seven savings banks in 2010 and taken over by the state in May in Spain's biggest-ever bank rescue, said it would shed 50 billion euros of assets including stakes in insurer Mapfre and airline International Airlines Group and its business in Miami in the United States.
Public debt holdings would fall to 30 billion euros from 40 billion euros currently, Bankia said, while shareholders will contribute 10.7 billion euros to the clean-up. Bankia shares fell 4 percent.
Holders of Bankia's hybrid debt would contribute up to 4.8 billion euros to the recapitalization, through losses incurred by swapping their holdings for shares, the bank said.
The European Commission said the cost to hybrid and subordinated bondholders in the restructuring of all four of the nationalized banks will come to about 10 billion euros.
Many hybrid debt holders at the nationalized banks are retail customers who say they were conned into buying complex financial instruments that buoyed banks' capital levels instead of fixed-term savings accounts.
The Spanish government, fearful of a political backlash, fought for these losses to be minimized, but Brussels insisted the subordinated bondholders share the pain in order to keep the use of taxpayers' funds to a minimum.
The commissioner said he would decide on other Spanish banks with capital shortfalls on December 20. Banco Popular has carried out a 2.5 billion euro share and rights issue to avoid the need to seek state aid.
(Additional reporting by Robin Emmott in Brussels and Jesus Aguado in Madrid; editing by Luke Baker and Anna Willard)