Madrid - The Spanish state will take control of the fourth-biggest listed bank, Bankia, the government said on Wednesday, as it races to shore up the bank's bad loan-ridden balance sheet.
The state will take a 45% stake by converting a state-backed loan of €4.465bn into shares, "meaning it will take control", the economy ministry said in a statement.
Prime Minister Mariano Rajoy's conservative government, which swept to power in December, had previously refused to countenance the use of public money to rescue the banks.
The dramatic but widely telegraphed move comes two days before his government announces broad banking reforms to ease the crushing burden of loans extended during a property bubble that imploded in 2008.
Bankia, an amalgam of seven shaky savings banks created in 2010, was at the centre of market concerns over fragile balance sheets, but analysts fear the rot goes much deeper.
One of the biggest worries for investors is that they do not know the real value of the banks' exposure to the property sector.
For the economy, it means many banks are struggling to clean up their balance sheets and are therefore reluctant to lend to households and businesses, potentially freezing up activity.
Bankia had the industry's largest exposure to the property market at €37.5bn at the end of 2011, of which €31.8bn were classed as problematic.
Madrid is throwing it a lifeline by converting into capital the state loan extended in December 2010 to Bankia parent group Banco Financiero de Ahorros (BFA).
The loan, which was handled by the state-backed Fund for Orderly Bank Restructuring (FROB), demanded an interest rate of 7.75% and was repayable over five years.
The Bank of Spain said it received Bankia's request for the state to convert the loan into capital on the same day new executive chairman Jose Ignacio Goirigolzarri was appointed.
The former Bankia's executive chairperson, Rodrigo Rato, who was previously a Spanish economy minister and who once led the IMF, announced his resignation on Monday as news emerged of the impending rescue.
"In any case, BFA-Bankia is a solvent entity that continues to function absolutely normally and its clients and depositors have no reason to worry," the Bank of Spain said in a statement.
An economy ministry official said the government would issue new rules on Friday forcing banks to boost their financial cushion against property assets, declining however to give a figure.
The new requirement could amount to €35bn, said business daily Cinco Dias. That is in addition to the €53.8bn in provisions already demanded in a reform announced in February.
In an attempt to soothe markets, the government had already said it would approve on Friday another reform aimed at enabling banks to transfer problem loans from their balance sheets to separate agencies.
Reports of the banking sector troubles sent the market borrowing rate on Spanish government bonds shooting above 6.0% for the first time since mid-April.
The Madrid stock market's leading IBEX-35 index slumped 2.77% to 6,812.7 points, the lowest finish since July 2003.
Santander, the eurozone's biggest bank by market capitalisation, plunged 4.52%, Bankia tumbled 5.84% and BBVA, Spain's second-biggest bank, fell by 4.7%.