MADRID (Reuters) - Spain said on Wednesday its rescue of problem lender Bankia would cost at least 9 billion euros ($11 billion), as the government tries to clean up a banking system that threatens to drag the country deeper into the euro zone crisis.
Losses at Spain's fourth largest bank are central to investors' fears that the country's fragile financial system, already vulnerable to rising default rates in a recession, could push Spain to seek an Irish-style bail-out.
Bankia's new management team will undertake a complete assessment of the lender's capital needs and will present its plan in mid-June, Economy Minister Luis de Guindos said in a presentation to a congressional committee.
The government will recapitalize Bankia's parent group BFA using the state-backed bank restructuring fund, the FROB, and then will fund Bankia through a capital increase including preferential shares for existing shareholders, he said.
He said the Bankia rescue would include 7.1 billion euros in provisions for losses from bad loans and 1.9 billion euros in capital buffers, as well as address valuations flagged by Bankia's auditors.
The clean-up of Bankia and BFA, which account for 10 percent of deposits in Spain, would take care of most of the problems in the country's banking system, he said.
"I insist BFA-Bankia is a specific case and it's not correct to extrapolate its problems to the rest of the Spanish financial system," he told lawmakers.
Bankia was partially nationalized earlier this month when it became clear it could not handle losses stemming from a 2008 property crash. But economists said the focus had now moved on the banking sector as a whole.
"The market has moved beyond Bankia. How much Bankia will get in aid is not going to make a big difference," said Martin van Vliet, senior economist at ING.
"The question is now about the long-term solvency of parts of Spain's banking system, especially what is going to happen with mortgage loan default. This concern is not being addressed."
Prime Minister Mariano Rajoy reiterated on Wednesday that Spain would not seek external funds to bail out its banks.
"The government has no interest and no intention in accessing any funds from the European Union or any other organization," Rajoy said following a meeting with French Prime Minister Francois Hollande on Wednesday.
A leading banking industry group, the Institute of International Finance (IIF), has said Spain's banks could need another 76 billion euros to cover losses as bad debts might rise as high as 260 billion euros.
Spain's banks hold 656 billion euros of mortgage debt, around twice their exposure to housebuilder loans. While the rate of loan default amongst real estate developers is around 21 percent, the mortgage default rate is low at 2.8 percent.
"Despite high levels of unemployment, default rates on mortgages are relatively low," said Maria Jose Lockerbie, managing director at Fitch Ratings, adding that this was partly due to low interest rates making debt service costs bearable.
However, economists fear the number of Spaniards defaulting on their mortgages could rise given the country's recession-bound economy and sky-high unemployment of 24 percent.
Financial markets are closely watching the banking sector to see if Spain will become the next casualty in the debt crisis that started in Greece. Four of Greece's largest banks got an 18 billion euro recapitalization on Tuesday.
The Spanish benchmark 10-year bond traded at a 6.2 percent yield on Wednesday, not far off the 7 percent level that is seen as unsustainable for a country's finances.
Spain last week converted 4.5 billion euros of state loans to parent company BFA (Banco Financiero y de Ahorros) into equity, giving it a majority stake in Bankia and partly nationalizing the lender.
GOLDMAN'S FEES
The government has picked Goldman Sachs to value Bankia and consultancies Oliver Wyman and Roland Berger were hired to audit other banks' loan books, damaged by a property crash that helped push bad loans to their highest in 18 years.
Spain has chosen outside auditors to reassure investors and European Union leaders, who were meeting at a summit on Wednesday, that Madrid has the situation under control.
Banking sources questioned whether consultants could wring more information from lenders than has already been given to institutions such as the International Monetary Fund and the central bank.
There have also been questions about the size of the fees the companies would earn at a time when the government is cutting spending to hit stringent budget deficit targets.
Advisers who have worked on other government bank restructurings said fees for Goldman Sachs would likely be lower than for other deals, with most firms agreeing to do such work for the prestige and in the hope that it brings new business.
One banking source said such government work usually commands fees of less than 500,000 euros. ($1 = 0.7838 euros)
(Additional reporting by Julien Toyer and Sonya Dowsett; Writing by Sonya Dowsett; Editing by Anna Willard)