Under the blueprint, banks would be required to recognize the losses on their bad assets by taking reserves against losses. The market already expects these banks to have negative book values. Formally recognizing the losses removes any guesswork about the exact magnitude.
To restore market confidence and show that they have come clean, banks would also be required to provide ultra transparency. Market participants can use this disclosure to confirm that all the losses were recognized.
With ultra transparency in place, Spanish banks can continue in operation for several years while they retain their earnings and rebuild their capital. This saves the Spanish government from having to provide the funds immediately.
By disclosing on an on-going basis their asset, liability and off-balance sheet exposures, market participants can also to a better job of assessing the Spanish banks as an investment opportunity. This makes the Spanish banks more attractive for investment.
Ultra transparency also allows the market participants to exert discipline to ensure that the banks do not try to gamble on redemption by increasing their risk levels.
Finally, by making the banks recognize their losses on their bad assets, Spain's government preserves its own financial capacity to a) credibly back-up its guarantee of bank deposits with an assist from the European Financial Stability Fund and b) invest in programs to spur economic recovery.
Spain's incoming prime minister, intent on curing the country's ailing banking sector, is considering cleanup plans that could dwarf the cost of previous efforts, including ... a move to force banks to dramatically boost loan-loss reserves, people close to the situation say.
Prime Minister-elect Mariano Rajoy has said he wants to speed up the process of dealing with €176 billion ($236 billion) of impaired real-estate assets from Spain's housing bust, although he played down the potential cost of his plans ahead of last month's elections.
The bad assets are choking off the flow of credit and making international investors wary of the euro zone's fourth-largest economy....
"It makes sense to give restructuring a push by cleaning up balance sheets; it signals things are moving along," said Tano Santos, a finance professor at Columbia University in New York. "That has been one of the most damaging things in the Spanish crisis: the lack of movement."
A more aggressive response won't come cheap. Analysts estimate a quick fix, such as setting up the bad bank or forcing banks to dramatically boost loan-loss reserves and providing government capital to backstop them, could cost the Spanish state as much as €100 billion.
That sum raises concerns that the effort could break the government's finances, as happened to the Irish government when it recapitalized its banks and blew out its deficit to 32% of gross domestic product in 2010.
But a growing chorus of economists and policy makers say the risks of failing to act decisively now are even greater; a new recession could further stress banks, and investor concerns about euro-zone debt problems threaten to scupper the common currency.
Previous cleanup efforts of the outgoing government of Socialist Prime Minister José Luis Rodríguez Zapatero have fallen short, largely because they were designed to spread the cost over time and avoid a big one-time hit to the government's finances.
Mr. Rajoy isn't expected to publicly disclose his plans for dealing with the collapse of Spain's decade-long housing boom before taking his oath of office sometime around Dec. 19.
But some people close the situation say the fastest way to deal with the problem would be to create a bad bank that purchases the impaired assets from lenders at discounted prices. This would force the institutions to recognize losses. It also would likely undermine their solvency ratios and require further funds to shore up their capital bases.
According to analysts at Morgan Stanley, Spain could acquire the entire €176 billion pile of impaired real-estate assets at the 58% discount applied by Ireland's bad bank, or a cost of €73.9 billion. This could be funded by swapping new government debt for the banks' soured real-estate assets.
However, the state would have to raise sufficient funds from investors to provide the banks with an estimated €28.5 billion in new capital to absorb losses that the banks would take in selling the assets at a steep discount. In all, the cost of the plan to the Spanish state could be €102.4 billion, or around 10% of Spanish GDP.
Still, if the €28.5 billion proves difficult to raise from private investors, given current market conditions, Mr. Rajoy has said he is open to the idea of requesting funds from the European Financial Stability Facility, the euro zone's bailout fund, to help finance the new capital needs. That is one of the facility's new mandates after it was revamped earlier this year.
Mr. Rajoy seemed to pour cold water on the bad-bank idea when, in the heat of his pre-election debate with Socialist rival Alfredo Perez Rubalcaba, he pledged not to give the banks a "single cent."
But one person close to the situation said Mr. Rajoy's team is studying the possibility of using Spain's deposit guarantee fund, which holds €6.59 billion and is financed by contributions from the banks, to pay for necessary capital injections. That wouldn't go against his campaign pledge because the bank-financed fund, not the government, would provide the cash.
Requesting money from the EFSF, however, would because the EFSF is funded by Spain and other euro-zone countries.
Spain's outgoing government approved new regulations on Friday that will double banks' annual contributions to the deposit guarantee fund to around €1.5 billion. These are paltry sums compared to the banks' likely capital needs, but a system could be devised whereby the deposit guarantee fund repays over time any monies the government injects in the banks now, the person said.
On the sidelines of a conference last week, Spain's central bank chief said the country's banks need further "restructuring" and urged the government to consider approaches that had previously been ruled out because of their high cost, including the creation of a bad bank.
"This mechanism should be studied…situations change," said Miguel Angel Fernández Ordóñez, noting that the EFSF was now on hand to provide financing.