Will Spain get Euro bank bail out as financial crisis deepens?

Europe's fourth-largest economy needs help as markets tumble and fears of a banking collapse mount

LAST UPDATED AT 12:16 ON Thu 31 May 2012

THE EUROPEAN Commission threw Spain, the latest frontline in Europe's debt war, two potential lifelines on Wednesday, offering more time to reduce its budget deficit and direct aid from a eurozone rescue fund to recapitalise distressed banks.

The Guardian reports that Jose Manuel Barrosos, president of the European commission, has suggested using the eurozone's new €500billion European stability mechanism (ESM) to inject capital into the country's banks. Germany has so far rejected this proposal and would need to agree for it to go ahead.

EU Economic and Monetary Affairs Commissioner Olli Rehn said Brussels was ready to give Spain an extra year, until 2014, to bring its deficit down to the EU limit of three per cent of gross domestic product, on the priviso that Madrid presents a solid two-year budget plan for 2013-14, something it has committed to do.

The financial crisis in Spain deepened last Friday: after weeks insisting that one of the country's biggest banks, Bankia, did not need fresh funds, ministers revealed a €23 billion hole in the accounts. They have yet to explain clearly how they will find the money when they are already struggling to finance a spiralling national debt.

The effect of the Bankia news on fragile financial markets was devastating, Bloomberg reports. Spanish shares dived to nine-year lows, the euro sank and investors fled Spanish government debt, pushing the yield towards the seven per cent level at which fellow eurozone members Ireland and Portugal were forced to seek national bailouts from Brussels.

The uncertainty has already caused a bank run of sorts: in the first four months of this year, more than €100 billion in private money has fled Spain for other European countries, an amount roughly equal to a 10th of the country's annual economic output. A European Central Bank measure of deposits in Spain's banks declined by €31.5 billion in April.

The euro sank to a 22-month low against the dollar of $1.245 today as investors flooded cash into safe-haven assets, The Wall Street Journal reports. Germany's cost of borrowing sank to an all-time low of zero as demand for ultra-safe bonds rocketed, meaning investors were willing to lend to Berlin for no return. Yields on US Treasuries - the world's ultimate risk-free asset - sank to their lowest levels since 1946.

"We are in an extremely perilous situation. People just want to put their money somewhere where they think they will get it back," Gary Jenkins head of Swordfish Research, a credit analysis company told The Financial Times.

"People may soon be paying Germany or the US to look after their money. You have to throw everything at Spain. The next intervention has to be massive in size and needs to show a total commitment." · 

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