Finance chiefs of the Group of Seven leading industrialised powers will hold emergency talks on the eurozone debt crisis today (5 June) in a sign of heightened global alarm about the situation in Spain.
With Greece, Ireland and Portugal all under international bailout programs, financial markets are anxious about the risks from a seething Spanish banking crisis and a 17 June Greek election that may lead to Athens leaving the euro zone.
"Markets remain skeptical that the measures taken thus far are sufficient to secure the recovery in Europe and remove the risk that the crisis will deepen. So we obviously believe that more steps need to be taken," White House press secretary Jay Carney told reporters.
Canadian Finance Minister Jim Flaherty said ministers and central bankers of the United States, Canada, Japan, Britain, Germany, France and Italy would hold a special conference call, raising pressure on the Europeans to act.
"The real concern right now is Europe of course – the weakness in some of the banks in Europe, the fact they're undercapitalized, the fact the other European countries in the euro zone have not taken sufficient action yet to address those issues of undercapitalization of banks and building an adequate firewall," Flaherty told reporters.
The disclosure of the normally confidential teleconference came as European Union paymaster Germany said it was up to Spain, the latest euro zone country in the markets' firing line, to decide if it needed financial assistance, after media reports that Berlin was pressing Madrid to request aid.
A G7 source, speaking on condition of anonymity because of the sensitivity of the issue, said there were concerns about the risk of a bank run in Spain, which is struggling to recapitalize nationalized lender Bankia and smaller banks stricken by the collapse of a property bubble.
"There is concern on whether there will be a bank run in Spain that could have repercussions beyond the euro zone," the source told Reuters.
Spanish Prime Minister Mariano Rajoy is pressing for a direct European rescue for his country’s banks with moral support from the European Commission, but Germany appeared to rule out such a "bailout lite" for the euro zone's fourth biggest member.
A source with knowledge of the matter said Madrid is working along with European institutions to find a way to directly refinance banks using rescue funds without the government having to come under a full EU/IMF bailout programme.
"Right now the most urgent issue is the banks, and there are negotiations to refinance the banks directly without it being an intervention. It's a mechanism for all [European] banks, not just for Spanish banks," the source said.
Under current rules Spain can get a loan from the European rescue fund, or EFSF, but it would come with tough conditions and intrusive supervision, with a high political cost for Rajoy. The new permanent European rescue fund, the European Stability Mechanism (ESM), due to enter into force in July, can lend to banks but the request still has to be made by the state.
The source with knowledge of the matter said Spain believed the European Union's executive could take a plan for bank aid to a summit of the bloc's leaders on 28-29 June.
EU Economic and Monetary Affairs Commissioner Olli Rehn said Brussels was considering direct bank recapitalisation by the ESM to break the link between weak sovereigns and ailing banks, but it was not possible under the treaty currently being ratified by member states.
"This is not part of the ESM treaty for the moment, in its present form, but we see that it is important to consider this alternative of direct bank recapitalisation as we are now moving on in the discussion on the possible ways and means to create a banking union," Rehn said.
Germany, the main contributor to the bailout fund, opposes changing the ESM treaty to allow direct bank recapitalisation and has veto power. Berlin contends that only a formal programme approved by national parliaments permits proper international supervision of how aid funds are spent.
Last week, the Commission adopted a package of proposals concluding the second European Semester of economic policy coordination and giving guidance for national policies in 2012-2013.
The major highlight of the reports was the situation in Spain, who faces a spiraling debt unless its banking sector receives massive help.
The Commission said the latest banking reform presented by Spain this month did not go far enough and needed to be strengthened to include provisioning on mortgages and lending to small businesses.
It also warned that unless policies are changed, Spain's debt will spiral to 100% of GDP by 2020. Madrid had one of the lowest debt ratios in the euro zone before the crisis at about 35 percent of GDP.
Spain has previously denied it would need an international bailout, following Greece, Ireland and Portugal.