As their losses from mortgages grow, Spanish banks have begun discussions about creating a separate entity _ a "bad bank" _ to take on these assets and relieve pressure on the country's financial sector.
The goal of the new organization would be to reduce the financial strain on banks and prevent the need for either a more costly government bailout or an international rescue along the lines of Greece, Portugal and Ireland.
News of the bank talks on Monday emerged as ratings agency Standard & Poor's downgraded the debt of 11 Spanish banks _ including Banco Santander SA, the eurozone's largest by market capitalization _ because of growing concerns about the effects of Spain's shrinking economy on the banking industry. S&P warned that five other Spanish banks are at risk of a similar downgrade.
The official for Spain's Economy Ministry confirmed Monday that the Spanish banking industry is discussing creating a private entity that would assume their toxic assets. The new asset management organization is designed to take the burden of trying to sell foreclosed properties off the banks and allow them to concentrate on providing credit to the private sector.
The official added that banks would be able to transfer toxic assets only if they had already set aside provisions under existing government rules. The government would not inject any taxpayer money into the creation of such an entity and its role would be limited to setting up rules for how it would work. The official spoke on condition of anonymity in line with ministry rules.
Spain's National Statistics Institute added to the country's worries Monday by announcing that it was officially back in recession as the country's economy shrank 0.3 percent in the first quarter compared to the previous three months. This is Spain's second recession in three years. The contraction follows a similar decline in the final quarter of last year.
The bursting in 2008 of a real estate bubble that powered the economy for more than a decade has saddled banks, particularly Spain's savings banks or 'cajas', with enormous amounts of bad loans. The country's central bank, the Bank of Spain, says the sector is still burdened with about (EURO)175 billion ($230 billion) in "problematic" real estate holdings. There are concerns that, as Spain's shrinking economy takes its toll on the banks, the government and possibly international lenders will be forced to step in and rescue the banks.
The government has already been pushing the lenders to strengthen their finances by merging and has introduced rules that require banks to set aside an estimated total of (EURO)50 billion ($65.7 billion) more in provisions by the end of the 2012 to cover their toxic real estate assets.
Spain's economic problems have become the focus of Europe's debt crisis as investors worry over Spain's ability to push through austerity measures and reforms at a time of recession and an unemployment rate hitting 24 per cent _ or 50 per cent for those aged under 25. Late last week, S&P downgraded the country's credit rating by two notches from A to BBB+, citing a worsening budget deficit, worries over the banking system, and poor economic prospects.
The austerity measures are aimed principally at slashing the government's deficit from 8.5 percent of economic output to the maximum level set by the European Union of 3 percent by 2013. For this year the goal is 5.3 percent.
With the economy shrinking, there are concerns that the government will not meet its targets and will be forced to seek a bailout. The National Statistics Institute on Monday said that compared to the first quarter of 2011, the economy shrank 0.4 percent. The Bank of Spain last week said the economy had shrunk 0.4 percent on the quarter. The statistics institute's findings are taken as the official figures.
Sunday saw tens of thousands people march throughout Spain to protest the conservative's government batch of emergency reforms and austerity measures.
But speaking the same day, Prime Minister Mariano Rajoy said the government would continue to make reforms week by week, claiming the gravity of the situation required this.
Daniel Woolls contributed from Madrid.