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People are reflected on the wall of Bankia headquarters building in Madrid, May 9, 2012. The Spanish government has converted Bankia's debt into equity and will have a controlling stake in the bank.


Hoping to put an end to a four-year banking crisis, Spain's government effectively took over Bankia SA, one of the country's biggest banks, late on Wednesday after days of market anxiety over the lender's viability.

The centre-right government of Prime Minister Mariano Rajoy told Spaniards the banking sector was safe and said more measures to strengthen ailing lenders would come on Friday after a February banking reform proved insufficient.

The sector has been through three major overhauls since a building and property market crash in 2008, which left lenders with what is now about €184-billion ($238-billion U.S.) in toxic assets including repossessed housing complexes that stand empty.

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Holding 10 per cent of deposits in Spain's banking system, Bankia is by far the largest of eight banks that the government has rescued over recent years. It was formed in 2010 when the government forced a number of weak savings banks into a merger to try to save them.

"Bankia is a solvent entity that continues absolutely normal operations and its clients and depositors have no cause for concern," the central bank said in a statement.

Bankia shares fell 3.0 per cent to 2.065 euros by 0908 GMT having hit an all-time low of 2.050 euros, down almost 16 per cent since news of an impending rescue emerged on Monday. But most other Spanish blue-chips were up, along with other European stocks that have been punished by concerns over Greece's political crisis and Spanish banks.

Spain's country risk, as measured by the spread between yields on its 10-year benchmark bond and the German benchmark, eased slightly but held close to six-month highs .

The state took complete control of Bankia's parent company BFA by converting an earlier €4.5-billion rescue loan into equity. That gives the government 45 per cent of Bankia, but it is expected to merge the two entities and control both.

The government is also expected to pump another €10-billion of loans or cash into Bankia to cover the hole from bad loans.

Some experts criticized the government's piecemeal approach over the past few months.

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"We saw a new law Feb. 2, and now on Friday there's another. It seems like a trial and error process. They don't know what they're doing ... This has done nothing to help confidence in Spain," said Robert Tornabell, professor of finance at ESADE business school.

The public seemed to have accepted the government's assurances on the bank's safety and so far there have been no signs of any deposit runs in Spanish banks. The central bank said there were no reasons for concern.

Inside a Bankia branch in Madrid there was a normal flow of about eight clients on Thursday morning. "I'm not worried. I know my money is safe ... Maybe people with more money don't see it that way," said Fernando Hernando, 42, an interior designer, who was in the bank on regular business.

For years banking analysts and critics have pushed Spain to go further in recognizing its banking troubles, which threaten to undermine the euro currency zone if the rescue is so expensive that it breaks Spain's public finances.

"Bankia has ended up in state hands because nobody accepted the reality of its financial situation in time," said an editorial in El Mundo newspaper, which is generally sympathetic to the ruling People's Party.

Bankia's exposure to troubled real estate assets, including loans at risk of default and repossessed properties from bankrupt borrowers, is some €32-billion.

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With the economy in a second recession since 2009 and one in four workers jobless, banks face rising loan defaults beyond those connected with the burst construction bubble.

The banks have also been unable to unload a massive pile of homes they have repossessed from property developers and from individuals. Home sales fell in March for a thirteenth consecutive month, official data showed on Thursday.

Home prices have dropped an average 22 per cent since the market collapsed in 2008, but many experts say there could be further to go.

According to financial sources, Spain will demand on Friday that banks set aside another €35-billion against loans to the ailing building sector - above and beyond the €54-billion they are already provisioning this year - raising the possibility more public cash will be needed to rescue the country's lenders.

The government is also expected to detail a "bad bank" type scheme to remove toxic assets from banks' books after looking at models from Ireland and other countries.

Mr. Rajoy had insisted for months that no more public funds were needed for the sector. But he had to make a U-turn as doubts persisted about Bankia, with the International Monetary Fund pointing to its vulnerability in a recent report and auditors Deloitte declining to sign off the lender's 2011 accounts.

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The government earlier this week forced out Bankia Chairman Rodrigo Rato, a former economy minister from the ruling party, and replaced him with Jose Ignacio Goirigolzarri, a prominent ex-banker from the Basque region.

Mr. Rato led Bankia's stock market flotation last year in an effort to increase the entity's capital and its transparency. Its share price has dropped more than 40 per cent since then.

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