The dramatic €100bn (£81bn) bailout for Spain's struggling banks was under immediate pressure yesterday as sceptical bond markets turned on Madrid and the European Central Bank urged more action on clearing up billions in sour property debt.
Spain's Prime Minister, Mariano Rajoy, who initially claimed victory in securing the rescue without further austerity and humiliating oversight, also faced a political blow as it emerged that financial assistance would be supervised by the so-called troika of the IMF, European Commission and ECB.
The latest developments came against a turbulent market backdrop as euphoria over the bailout quickly gave way to doubts over the long-term effectiveness of the rescue. Spain and Italy benefited from falling debt costs early on, but a sudden U-turn by markets spooked by a lack of detail saw the borrowing costs of both nations surge again later.
Spain's benchmark 10-year yields swung wildly from below 6 per cent to as high as 6.47 per cent in a volatile session. Big early gains for global stock markets were also pared back as doubts over the deal grew, with London's FTSE 100 eventually closing down 2.7 points at 5,432.37.
Analysts said a key unanswered question was whether the funds will come from the original European Financial Stability Facility bailout pot, whose debt is ranked equally with sovereign debt holders, or the new European Stability Mechanism. If the money comes from the ESM, this debt takes priority, leaving Spanish bondholders potentially exposed to losses in a default.
Michael Symonds, financial analyst at Daiwa Capital Markets Europe, said: "The brevity of the rally in risk assets simply goes to highlight how the breadth of challenges facing Spain and the euro area extends far beyond the solvency of the Spanish banking sector. It also emphasises the lack of detail so far in the announced reforms, in particular the uncertainty over the potential for the euro area's bailout loan to subordinate existing Spanish government bondholders."
Madrid also faced pressure from the ECB to strengthen its plans to create "bad banks" where the lenders would park toxic property loans to sell them off. Spain's banks are laden with €184bn in "problematic" property loans according to the Bank of Spain, and the creation of separate asset management companies for the loans is seen as crucial to clearing up the mess.
"It remains unclear...whether the envisaged framework is sufficient to achieve an effective separation of the risks of banks," the ECB warned yesterday. Its legal opinion is a blow for Spain, which is likely to be forced to review the reform. The ECB also wants the Spanish government to make clear how the bad banks will be funded and whether they will be backed by state guarantees.
Mr Rajoy's claims that Madrid will not be subject to outside supervision were immediately quashed by EU Competition Commissioner Joaquin Almunia, who said the troika would oversee financial assistance.
Mr Almunia said the IMF would be fully involved in monitoring Spain's programme even though it was not contributing funds, and banks that received ai d must present a restructuring plan. "Of course there will be conditions. Whoever gives money never gives it away for free."
Ireland's leadership was also fighting to rebut claims that Spain had secured a better bailout deal than its own rescue in November 2010. Deputy finance minister Brian Hayes said: "They got the exact same deal that we got."