Spain long hesitated to ask for EU rescue funds to help the country's ailing banks. But at the end of June, Prime Minister Mariano Rajoy's conservative government admitted that Spain would not be able to to prop up its banks alone. If Madrid attempted to scrape together more Spanish funds for the cause, the country's already poor credit worthiness would have deteriorated even further. The EU hopes to break Spain's vicious cycle between bank debt and state debt with this latest agreement.

In the deal, EU rescue funds will go directly to Spanish banks instead of forcing the Spanish government to accept a bailout itself. That measure came on condition that Spain submit to a common supervising mechanism for EU banks once a permanent bailout fund, known as the European Stability Mechanism (ESM), is established.

Prior to the latest agreement, Spanish banks were reliant on a fund paid for by the Spanish government called the Fund for Orderly Bank Restructuring, known by its Spanish acronym FROB. Under FROB, Madrid was solely responsible for Spanish banks.

No distortion of competition

Up to 100 billion euros in rescue funds will be available to Spanish banks. Just how much they need will be determined through an audit. The first 30 billion euros, though, are to be ready by the end of this month.

The funds come with a number of conditions. Experts from the European Commission, the European Central Bank (ECB) and the International Monetary Fund (IMF) - which is not actually contributing to the rescue funds - will supervise Spanish reform efforts.

Banks still believed to have a future will be put on a solid basis, but others deemed to be insalvagable will be liquidated or forced to merge with other banks. The European Commission is charged with making sure EU competition rules are respected and that there is no distortion of competition during the process.

Aid tied to reform efforts

Olli Rehn, the EU Commissioner for Economic and Monetary Affairs, announced the bailout's aims in a recent release.

"The aim of this program is very clear," he wrote, "To provide Spain with healthy, effectively regulated and rigorously supervised banks that are capable of nurturing sustainable economic growth."

The bailout agreement also calls for Spain to fulfill consolidation goals previously set by the European Commission. Spain is to lower its budget deficit to less than three percent of its gross domestic product. The current level stands at nine percent of GDP. The 2014 deadline marks a year longer for Spain to gets its house in order than initially planned.

Rehn stated that connecting the bailout package to debt reduction was quite intentional.

"The euro group is convinced that the reforms attached to this financial agreement will contribute to ensuring a return of all parts of the Spanish banking sector to soundness and stability," he said.

Massive protests

Spain's austerity measures are putting Rajoy on a collision course with Spanish voters. Hundreds of thousands have protested against cuts that stand to dramatically affect their daily life. In the end, though, successfully rescuing the banks will depend on public support.

At the same time, news of the Spanish bailout and accompanying austerity package have yet to placate the markets. That means Madrid still has to pay high interest when borrowing money.

Spain itself, and not just its banks, may yet need help from the EU. In light of the tense mood on the street, Rajoy is likely to try avoiding that for as long as possible. A bailout for Spain would almost certainly require harsher austerity measures than the ones tied to the bank rescue.

Eurozone ire

The majority of Germans reject help even if it's just for Spanish banks. According to a recent poll by German broadcaster ARD, about 52 percent of Germans are against the bailout and only 38 percent favor it. Other eurozone countries are equally critical of the agreement. Finland, for instance, agreed to the bailout. But it pushed through a separate deal with Spain to secure collateral in exchange for Helsinki's contribution to the rescue package.

Author: Christoph Hasselbach / ai
Editor: Shant Shahrigian