MADRID -- In a bid to strengthen its finances and avoid a European rescue, Spain moved to overhaul its entire banking system Friday, forcing lenders to come up with $40 billion to cover real-estate losses and allowing them to set aside their toxic assets.
With one in four workers out of a job, Spain has slashed spending and raised taxes to comply with European Union fiscal rules, but its borrowing costs remain near levels that sent Greece, Ireland and Portugal into bailouts. Investors fear Spain may be next. Its banks are the weakest link, weighed down by unpaid loans left over from a housing boom that went bust in 2008.
The government nationalized the country's largest real-estate lender, Bankia, late Wednesday.
The danger is that once foreclosed homes and other assets are devalued to current market prices, the losses could bankrupt the lenders and sabotage the entire Spanish economy.
Under the new rules unveiled Friday, Spanish banks will collectively have to come up with $40 billion to balance out bad property loans, or acquiesce to government loans at a 10% interest rate. Banks will also be allowed to move non-performing assets -- unpaid loans or foreclosed properties -- off their balance sheets into separate entities, for resale at market prices.
Economy Minister Luis de Guindos acknowledged that Spain's economic health depends on these actions.
"Without certainty about the solvency of the banking sector, economic recovery is much more difficult," he said at a news conference Friday.
He said the 10% government interest rate would mitigate the cost to taxpayers. But many economists say the cost of banking reforms could be in the tens of billions of dollars, mostly shouldered by the state.
"It is very difficult for the banks to be able to come up with capital or additional funding on their own, because the markets are dried out," said Fernando Fernandez, an economist at Madrid's IE Business School. "The euro debt crisis has deteriorated, the growth picture has also deteriorated and the aversion of investors to invest in real estate or banks in Spain is very high."
Carving off bad assets from banks' balance sheets might help in the short term, Fernandez said, "but the loss will still be there. The government -- and taxpayers -- will eventually have to pay for this."
Any expenses could make it harder for Spain to comply with EU spending rules. Spain's deficit was 8.5% last year, nearly three times the mandated limit. On Friday, the EU issued its twice-yearly economic report, forecasting that Madrid would miss its 2012 and 2013 targets by a wide margin.
-- Lauren Frayer
Photo: In Madrid, Spanish Economy Minister Luis de Guindos unveils an overhaul of Spain's troubled banking sector on Friday. Credit: Jaime Reina / AFP/Getty Images