Spanish debt yields jumped and shares in troubled lender Bankia plunged to record lows, highlighting a lack of confidence in government efforts to stabilise the finances of Spain and its ailing banks.
Government sources told Reuters Spain may recapitalise Bankia with sovereign paper in return for shares in the bank and could use this method to prop up other troubled lenders - moves which would send the country's debts above the 79.8 per cent of economic output which had been expected this year.
"This method has been used by Germany and by Ireland in the past. It is perfectly valid," a government source told Reuters on Monday.
The source said the European Central Bank (ECB) had been informed of the plans and did not object to them so far, though a final decision had not yet been made on which option to take to prop up the lender.
Some investors speculate that weak banks, undermined by the end four years ago of a decade-long property boom, coupled with the indebtedness of the regions, could force Spain to seek an international bailout, which the euro zone can barely afford.
The premium investors require to hold Spanish government bonds over their German counterparts hit a euro-era high at 505 basis points, up 8 points on the day, after Bankia requested a record bailout over the weekend.
The yield on benchmark 10-year government bonds rose to 6.46 per cent, the highest since November.
Despite the €23.5 billion rescue, Bankia shares tumbled more than 10 per cent, pressuring some weaker peers as scrutiny rose over how the government plans to finance such rescues, especially if more lenders need help.
Its drastic hike in provisions to cover potential losses from repossessed property and souring consumer debt has raised the prospects that other banks may need to do the same, as a sector-wide independent audit gets underway.
Bankia parent BFA is set to report the biggest loss in Spain's banking history today.
"The figures are much higher than any other release from any other bank," a financial source with direct knowledge of the bank's situation told Reuters.
Bankia, marked out by the Spanish government as its single- biggest banking problem, has so far insisted the extent of its own possible losses could not be extrapolated to the rest of the country's banking system.
"The events at Bankia will reinforce the view that the upcoming external review should identify a significant recapitalisation need for the Spanish banking system," analysts at Nomura said in a note, putting a recapitalisation of the whole sector at between €50 and €60 billion, with the main listed banks requiring an additional €16 billion.
