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MADRID (Reuters) - Spanish debt yields jumped and shares in Bankia SA plunged to record lows on Monday after the government, struggling to sort out its finances, put forward a plan to revive its fourth-largest lender involving more public debt.
Prime Minister Mariano Rajoy pinned the blame for rising Spanish borrowing costs on concern about the future of the euro zone and again ruled out seeking outside aid to revive a banking sector laid low by a property boom that has long since bust.
"There are major doubts over the euro zone and that makes the risk premium for some countries very high. That's why it would be a very good idea to deliver a clear message there's no going back for the euro," Rajoy told a news conference.
"There will not be any (European) rescue for the Spanish banking system," Rajoy added, before backing calls for the euro zone bailout fund, which will be in place from July, to be able to lend to banks direct.
Government sources told Reuters Spain may recapitalize Bankia with sovereign paper in return for shares in the bank and could use this method to prop up other troubled lenders - moves which would push the country's debts above the 79.8 percent of economic output which had been expected this year.
"This method has been used by Germany and by Ireland in the past, it is perfectly valid," a government source told Reuters.
The source said the European Central Bank had been informed of the plans and did not object so far, though a final decision had not yet been made on which option to take.
Bankia's parent company BFA has asked for 19 billion euros ($23.8 billion) in government help, in addition to 4.5 billion the state has already pumped in to cover possible losses on repossessed property, loans and investments.
Investors increasingly believe weak banks, undermined by the collapse four years ago of a decade-long property boom, coupled with indebted regions, could force Spain to seek an international bailout, which the euro zone can barely afford.
With stock markets generally buoyed on Monday by polls giving a pro-bailout Greek party a slender lead ahead of June 17 elections, the fact that the premium investors require to hold Spanish government bonds over German counterparts hit a euro-era high at 505 basis points, denoted a distinct lack of confidence in Madrid's efforts to stabilize its finances and ailing banks.
Having dropped to around 4.7 percent earlier this year, helped by the ECB's creation of a glut of three-year money, 10-year borrowing costs are now approaching 6.5 percent and closing in on the 7 percent level widely seen as unsustainable.
Ireland and Portugal were frozen out of capital markets and forced to seek international bailouts soon after their yields topped 7 percent.
"If it goes on for much longer, it just adds to the burden of fiscal consolidation," said Elisabeth Afseth, analyst at Investec in London. "If a large part of that is spent on paying a premium to borrow, it just makes it so much harder."
Spain's great advantage is that it has issued well over half the debt it needs to this year, in the first five months.
But that may no longer hold true.
The government said last week its highly indebted regions faced 36 billion euros of debt refinancing bills this year, way above the previously stated 8 billion. Catalonia said it was running out of options and needed central government help.
A plan to recapitalize Bankia with Spanish government bonds, which the bank could then use as collateral to get cash from the ECB, could add to the government's refinancing problems.
Spain's Treasury insisted it would repay debt maturing without problems.
"We are in a very strong position (to meet debt maturing shortly)," said Ignacio Fernandez Palomero, deputy director of public debt at the Treasury, pointing to redemptions in July and October, when Spain has big amounts due.
Meanwhile, Bankia parent BFA is set to report on Monday the biggest loss in Spain's banking history.
"The figures are much higher than any other release from any other bank," a financial source with direct knowledge of the bank's situation told Reuters.
Despite the 23.5 billion euros rescue cued up for Bankia, its shares tumbled by about 12 percent, pressuring some weaker peers.
Its drastic hike in provisions to cover potential losses from repossessed property and souring consumer debt has raised the prospects that other banks may need to do the same.
A wider audit of Spain's banking system should reveal by June what capital gap other banks will need to fill.
"The events at Bankia will reinforce the view that the upcoming external review should identify a significant recapitalization need for the Spanish banking system," analysts at Nomura said in a note, putting a recapitalization of the whole sector at between 50 and 60 billion euros, with the main listed banks requiring an additional 16 billion euros.
Nomura said only BBVA, Santander and Sabadell would not need to strengthen their capital, while the government would need to clean up smaller lenders it has already propped up, such as Banco de Valencia, Novacaixagalicia and Catalunya Caixa.
"Given the current economic and political uncertainties facing the euro zone, this could see additional pressure on Spain to consider using external funds for the bank recapitalisation," Nomura said.
Additional reporting by Jesus Aguado; Writing by Mike Peacock; Editing by Fiona Ortiz and David Holmes