Spain's economic crisis intensified yesterday as Madrid prepared to pump at least €15bn (£12bn) into the country's fourth-biggest bank, sending the euro plunging on a fresh day of turmoil for the eurozone.
Shares in Bankia, which has already been propped up by the Spanish taxpayer, were suspended on the Madrid stock exchange ahead of the move. Spain's cost of borrowing on international money markets also soared as Catalonia – the country's wealthiest region – said it may need a handout from the central government to pay its bills.
Last night, in another blow to the embattled nation, the Standard and Poor's ratings agency downgraded the credit ratings of five Spanish lenders including Bankia, which, along with Banco Popular Español and Bankinter, was cut to junk.
The latest crisis comes against a backdrop of alarm over a possible Greek exit from the single currency, a prospect which has sent tremors through global stock markets this week. Yesterday, the euro fell below $1.25 to a fresh 22-month low against the dollar and also lost ground against the pound.
As well as Bankia's bailout in Spain, Greece's four biggest lenders were also in line for an €18bn capital injection under the terms of its €130bn rescue. Even Scandinavia's much stronger banks were under the spotlight as the ratings agency Moody's cut its credit ratings on three of the biggest players in Norway and Sweden, citing the potential impact of the debt crisis on their access to funding.
Fund managers have caught fright at the increasing risk of contagion in the eurozone ahead of a possible Greek exit, and are rushing to dump euro assets. This week's inconclusive Brussels summit did little to inspire confidence and Citigroup analysts warn that the euro could even fall to parity with the dollar.
Markets remained jittery yesterday despite reports that Angela Merkel, the German Chancellor, was drawing up a plan to boost Greece and protect the eurozone. Der Spiegel magazine said Germany was working on proposals that included special economic zones in troubled countries to attract investment.
Meanwhile, Madrid is in the process of nationalising Bankia, which holds some 10 per cent of Spain's bank deposits, after it was unable to raise enough capital to cover heavy losses from loans to property developers. Spain has made several unsuccessful attempts to tackle the banking sector's €300bn exposure to a property boom in 2007-08.
With €184bn of these loans said to be "problematic" by Spain's central bank, the scale of the crisis is such that investors fear Prime Minister Mariano Rajoy's centre-right government will have to ask for international aid to prop up its lenders. The nation has, meanwhile, slumped back into recession as Mr Rajoy looks to slash €45bn from the budget to bring down the deficit.
Madrid has demanded that the banks set aside an extra €84bn in provisions for property losses this year as well as spinning off bad debts into separate asset management companies. The government has already spent €4.5bn to prop up Bankia and the entire rescue now totals some €20bn. Michael Symonds, an analyst at Daiwa Capital Markets Europe, warned Bankia was the "tip of the iceberg" and criticised Spain for taking a "piecemeal approach". He warned: "Our view is that if Greece leaves the euro and contagion spreads to Spain and Italy, no amount of capital will be adequate."
Spain will have to go to the markets to raise debt to put into Bankia at a time when its borrowing costs are heading towards unsustainable levels. But its job was made even harder yesterday after the warning from Catalonia – which accounts for a fifth of the Spanish economy – that it was running out of options over refinancing €13bn of debt falling due this year.
The Catalan President Artur Mas said: "We need to make payments at the end of the month. Your economy can't recover if you can't pay your bills." The prospect of yet more borrowing by Spain sent its 10-year borrowing costs up to 6.27 per cent, back towards the 7 per cent level seen as the trigger for a bailout.
The debt burden of Spain's 17 devolved regions – alongside the bad loans of its banks – could stretch finances to breaking point. All of the regions together have €36bn in debt to refinance this year, as well as an authorised deficit of €15bn. Last year, many of the regions financed debt by falling months or even years behind in payments to service providers such as street cleaners.
Greece's central bank chief, George Provopoulos, said extra funds for his country's biggest banks were "important in a period of great uncertainty".
Moody's cut its ratings on Sweden's Nordea and Handelsbanken, and Norway's DNB, by one notch, despite healthy economic growth and some of Europe's strongest capital buffers.
€184bn ‘Problematic’ loans made by Spanish banks to fund 2007-08 property bubble
Struggling banks: A Europe-wide problem
The dependence of Spanish banks on the ECB for funding has ballooned in the past year, rising from €43.8bn (£35.1bn) in April 2011 to a mammoth €316.9bn last month.
Moody's has cut its ratings on 26 of Italy's biggest banks as its economy faces a third quarter of recession and austerity measures.
In Paris, the big concern is the exposure of French lenders to peripheral eurozone nations – $491.4bn (£313.6bn) to Italy, Spain and Greece as of the end of 2011, according to the Bank for International Settlements.
Following last year's bailout, Portugal's banks are still largely frozen out of money markets and borrowed €55.4bn from the ECB in April.
Though stronger, banks in Sweden and Norway suffered credit ratings cuts yesterday, partly owing to the European debt crisis.