Luxembourg/Madrid: Independent auditors said Spanish banks may need up to 62 billion euros in extra capital, to be filled mostly by a euro zone bailout, after Spain's medium-term borrowing costs spiralled to a euro-era record on Thursday.
Euro zone finance ministers met in Luxembourg to discuss how to channel up to 100 billion euros in aid to Spanish lenders weighed down by bad debts from a burst property bubble. Madrid's economy minister said a formal request would be made in days for the bailout, which was agreed two weeks ago.
Many in the markets see the package as a mere prelude to a full programme for the Spanish state, which Madrid vehemently denies it will need.
Spain's financial plight took centre stage a week before a European Union summit tackles long-term plans for closer fiscal and banking union in a bid to strengthen the euro's foundations, after bailouts for Greece, Ireland and Portugal failed to end a 2-1/2-year old debt crisis.
To pave the way, the leaders of Germany, Italy, France and Spain will meet in Rome on Friday.
"We are clearly seeing additional tension and acute stress applying to both banks and sovereigns in the euro area," International Monetary Fund chief Christine Lagarde, who attended the Luxembourg meeting, told reporters.
"With that in mind, the IMF believes that a determined and forceful move towards complete European monetary union should be reaffirmed."
Two independent audits by consultants Roland Berger and Oliver Wyman found that Spanish banks would need between 51 and 62 billion euros in extra capital to weather a serious downturn in the economy and new losses on their books.
The Bank of Spain said the 100 billion euros offered to Madrid two weeks ago would give a wide margin of error. Spain's three biggest banks would not need extra capital even in a stressed scenario, it said. The government said it did not expect to shut any banks and would restructure those in trouble.
In Luxembourg, the finance ministers decided Spain should initially apply to the euro zone's temporary rescue fund, the European Financial Stability Facility, with the loan taken over by the permanent bailout fund the European Stability Mechanism (ESM) once it is up and running after July 9.
"The financial assistance will be provided by the EFSF until the ESM becomes available, and then it will be transferred to the ESM," Jean-Claude Juncker, who chairs the Eurogroup of finance ministers, told a news conference.
"We would expect the Spanish authorities to put forward a formal request for financial assistance by next Monday," he said.
Such a solution should avert a problem which had scared investors: debt issued by the ESM must be paid back first in case of a Spanish default, relegating private creditors lower in the pecking order. Because the new bailout debt will originate from the EFSF it will be issued without that requirement.
Earlier on Thursday, Madrid sold 2.2 billion euros in medium-term bonds, drawing strong demand almost entirely from domestic banks. Yields on 5-year paper rose to a 15-year high of 6.07 per cent, a level regarded by analysts as unaffordable for any prolonged period.
"They raised 2.2 billion versus a 2 billion target, so they can raise the money," said Achilleas Georgolopoulos, a strategist at Lloyds in London.
"Then the (question is), are the yields threatening for the medium term? And yes, clearly they are much higher than the previous auction ... But still they can continue for a few months to fund at these levels."
The finance ministers also signalled there may be some leeway for Greece, following the formation of a coalition of mainstream parties committed to the country's 130 billion euro EU/IMF bailout but determined to renegotiate some of its terms.
Athens will ask lenders for two more years to hit fiscal targets and an extension to unemployment benefits as it seeks to soften the punishing terms of the bailout that saved the country from bankruptcy.
Greece's euro zone partners, in particular paymaster Germany, have offered modifications but no radical re-write of the conditions attached to the lifeline agreed in March.
Juncker said nothing would be decided until the troika of EU, IMF and European Central Bankers had returned to Athens for a look at the books, starting on Monday.
"We will have a look into the findings of the troika and then we will discuss in detail the different means and instruments which can be used," he said. "It doesn't make sense for the time being to give more precise indications on the content of the programme."
The German government and opposition reached a deal that will allow parliament to approve the ESM next week, but Germany's top court may delay the rescue fund's start date, saying it needed time to study the treaty.
The ESM cannot come into effect without approval by Europe's biggest economy. Ratification also requires the signature of the president and a nod from the constitutional court in Karlsruhe.
The parliamentary floor leader of Chancellor Angela Merkel's conservatives appeared to dash French and southern European hopes of nudging Berlin towards common euro area debt issuance, saying there would be no mutualisation of debt in Europe.
Italy disclosed that it was missing its target to lower the budget deficit to 1.7 per cent of gross domestic product and will have to cut spending by a further four billion euros to meet the goal.
Italian Prime Minister Mario Monti suggested, on the sidelines of this week's G20 summit, using the euro zone's rescue funds to buy the bonds of Spain and Italy in the secondary market to bring down their borrowing costs.
Monti hosts Spanish premier Mariano Rajoy, Germany's Merkel and French President Francois Hollande in Rome on Friday and is also expected to raise the idea there. Merkel has played down the proposal, which investors said might be counter-productive unless the ECB stepped in decisively in support.
Any European bond-buying would come with strings attached, equivalent to the sort of bailout programmes that Rome and Madrid are trying to avoid because of the stigma attached.
Given the limited capacity of the temporary EFSF and planned permanent ESM rescue funds, with at most 500 billion euros available, a senior EU source said such intervention would make sense only if the ESM had a banking licence enabling it to borrow from the ECB. Germany has so far opposed that idea.