Spanish bank bailout moves forward

@CNNMoneyInvest July 20, 2012: 3:09 PM ET
eurogroup

Eurogroup president Jean-Claude Juncker and other eurozone finance ministers back a rescue of Spanish banks.

NEW YORK (CNNMoney) -- Eurozone finance ministers on Friday approved the terms of a bailout for Spanish banks and agreed to set aside €30 billion in emergency funds.

The move was widely expected, but yields on Spanish government bonds continued to rise as investors remain skeptical that the recapitalization of Spanish banks will proceed as planned.

Yields on 10-year Spanish bonds rose to a record high of 7.28%, a level that economists say Madrid cannot afford to pay for long.

The loan agreement "is warranted to safeguard financial stability in the euro area as a whole," the Eurogroup of eurozone finance ministers said in a joint statement.

The group of 17 ministers unanimously agreed to provide up to €100 billion in financial assistance for Spain, although the final amount of the loans will not be known until a full assessment of the Spanish banking sector is complete.

In exchange, Spain will be required to restructure the nation's banking sector, which has been struggling with the fallout from a massive property bust.

The ministers said a Memorandum of Understanding will be signed "in the coming days" to help strengthen Spain's economy and bolster its commitment to meeting deficit reduction targets.

Spanish Prime Minister Mariano Rajoy recently announced plans to cut €65 billion in public spending by reducing government bureaucracy and raising taxes.

Spain will also be required to abide by European Union laws as it consolidates its banking sector, "to ensure that the banks that emerge at the end of the process will be viable entities that will not need further public support," said Olli Rhen, the EU's commissioner for economic and monetary affairs.

The Eurogroup agreed to set aside an initial €30 billion for "urgent unexpected financing needs," which Juncker previously said would be disbursed by the end of July.

The loans, including the €30 billion, will initially be made by the European Financial Stability Facility, but the European Stability Mechanism will eventually take over as creditor. The ESM is not expected to be up and running until at least mid-September, following a review of its legality under the German constitution.

The loans will be made to Spain's bank resolution authority, the Fund for Orderly Bank Restructuring, which will inject the capital directly into insolvent banks, according to the Eurogroup.

The FOBR will act as an agent of the Spanish government, the ministers said. But the government "will retain the full responsibility of the financial assistance."

The agreement was announced one day after the German Parliament voted to approve the EFSF loans. However, some German politicians have insisted that the Spanish government guarantee the loans it will receive from the ESM, once it has been ratified.

The concern is that requiring Madrid to guarantee the loans would shift the liability back onto its books, adding to its debt load at a time when the government is struggling to shrink its deficit.

Spain sold €2.98 billion worth of two-, five- and seven-year notes this week, but demand was weak.

Yields on 5- and 10-year Spanish paper have now exceeded the highs prior to last month's EU summit, notes Nicholas Spiro, director of London-based consultancy Spiro Sovereign Strategy.

The risk premium on Spanish debt is partly "a result of market misgivings regarding the structure and scope of the bailout package," said Spiro. "The next batch of auction results are likely to be even worse."  To top of page

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