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MADRID - Spain's debt risk premium shot to a euro-era record Tuesday as stricken banks scrambled to clean up bad loans and investors feared the state would end up footing the bill.
The sovereign debt risk premium -- the extra return investors demand to hold Spanish bonds over their safer German counterparts -- leapt to a euro-era record of 516 basis points (5.16 percentage points).
Markets buckled on signs of a banking system under stress as it is forced to abide by tough new requirements even as it struggles with a vast exposure to the collapsed property sector.
The government this month instructed banks to set aside an extra 30 billion euros ($38 billion) in 2012 in case property-related loans go bad, on top of 53.8 billion euros required under reforms enacted in February.
Under pressure to bolster the balance sheets, three Spanish savings banks -- Ibercaja, Liberbank and Caja3 -- announced they would vote on a merger later in the day.
Another lender, Banco Popular, whose long-term debt was downgraded Friday to junk-bond status, said it was trying to sell its online banking to find the cash to clean up its books.
But the big preoccupation was news that Prime Minister Mariano Rajoy's conservative government is considering issuing sovereign debt and injecting it directly into recently nationalised lender Bankia.
An Economy Ministry spokeswoman, however, said the preferred option would be to sell bonds on the market and use the proceeds for the banks.
"Spain's cunning idea is to issue government debt which it will hand to the troubled institution," said a report by analysts at Moneycorp in London.
"Bankia will use the bonds as collateral against which to borrow from the European Central Bank. But this is a lot to ask of the ECB. It will not be overjoyed at the prospect of loading up with yet more questionable assets and might refer the matter to the other members of the troika in charge of the EU and IMF bailout funds."
Bankia's board on Friday asked the state to inject 19 billion euros to help it abide by more stringent capital rules, and some media said other banks could need yet another 30 billion euros.
The government had already injected 4.465 billion euros into Bankia this month by converting a loan to its parent group into capital.
On the stock market, Spain's IBEX 35 index dived 1.67 percent to 6,295.4 points.
In foreign exchange deals, the European single currency fell to $1.2536 from $1.2541 late in New York on Monday.
"It is not surprising Spain equity market is suffering losses," said trader Anita Paluch at Gekko Global Markets in London.
"The negative sentiment is prevailing, as investors are watching the Spanish bonds to hit 7.0-percent mark -- a level that is considered a breaking point, at which Spain will need to revert to international financial help in order to get out of trouble.
"It's actually something we have seen back in the days when Greece, Ireland and Portugal had to be bailed out."
Banco Popular shares slumped 4.32 percent to 1.64 euros after the news broke that it is seeking new capital, adding to a 7.57-percent plunge the previous day.
"Banco Popular is in negotiations for the sale and outsourcing of a majority stake of its internet banking and means of payment businesses, although no agreement has been reached as of today," it said in a statement.
French banking group Credit Mutuel-CIC, which has a five-percent stake in Popular, could be among the interested buyers, a source close to the deal told AFP.
Banco Popular expects to reap a profit of about two billion euros from the sale, the source said.
The bank's ability to borrow on the markets was hampered by Standard & Poor's decision Friday to downgrade its long-term debt to BB-plus -- junk bond status -- from BBB-minus.
The rating was left with a negative outlook.
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