An Economy Ministry spokesman said yesterday that the government was considering using an injection of treasury debt instead of cash to recapitalize BFA-Bankia, as laid out in legislation approved in February. Spanish bond yields rose and investors criticized the idea, which the spokesman said today had become a “marginal” option for the 19 billion-euro ($24 billion) rescue.

Spain is trying to shore up its banks and help cash- strapped regions at a time of surging borrowing costs. The yield difference between Spanish and German 10-year bonds rose to the highest since the creation of the euro this week. As Spain’s market access narrows, it depends increasingly on domestic lenders, which in turn are getting cash from the European Central Bank.

The government has said it is designing a mechanism to help regions regain access to capital markets. To avoid adding to the burden on the sovereign, the government is considering guaranteeing joint regional bond issues with their tax revenue, three people familiar with the plans said.

Risk Premium

Spain’s 10-year yield has risen 60 basis points since the day before BFA-Bankia was nationalized on May 9, even as Rajoy said yesterday that the move had no impact on the nation’s risk premium. The yield was at 6.43 percent at 1 p.m. in Madrid.

“It looks like Spain is going to have to tap an external balance sheet one way or another,” Andrew Bosomworth, managing director at Pacific Investment Management Co., said in an interview today with Bloomberg Television. “It clearly wants to avoid the form that the other countries have taken so far because their experience hasn’t been good.”

The cost to the taxpayer of the Bankia bailout has been swelled by the fact that alternatives, such as forcing bond investors to bear the cost, would hurt ordinary depositors at Spain’s third-biggest lender. Bankia is among Spanish banks that sold 22.4 billion euros of preferred stock to individual investors through branches, according to data compiled by CNMV, the markets supervisor. In a so-called bail-in, those investors would be wiped out before holders of more senior bonds, which tend to be institutions.

4.5 Billion-Euro Rescue

The Bankia group, which took a 4.5 billion-euro rescue in 2010, asked for another 19 billion euros on May 25 to recapitalize and clean up its balance sheet as it took provisions that went beyond what two bank decrees this year called for. Spain’s bank-rescue fund, which has already committed 18.7 billion euros, equivalent to 1.8 percent of gross domestic product, to struggling banks, has 5 billion euros in cash. That means Spain’s ability to bail out Bankia depends on the Treasury’s access to markets.

Foreign investors cut their holdings of Spanish debt to 37 percent of the total in circulation in April from 50 percent at the end of last year. Domestic lenders, bolstered by emergency funding from the ECB, have picked up the slack, increasing their share to 29 percent from 17 percent over the same period. At a bond auction on May 17, foreigners took 20 percent to 30 percent of the issue, a government official, who declined to be named, told reporters.

Struggling Banks

Rajoy repeated yesterday that he wouldn’t seek a European rescue for his nation’s banks. Still, he said the European Stability Mechanism, which is due to start operating as a permanent rescue fund in July, should be able to recapitalize struggling banks directly, bypassing national governments.

European leaders are split over the issue, an EU official said on May 22, as the statutes say support must be channeled through national governments. Rajoy said “a lot of people” agreed with him, without giving details. German Finance Minister Wolfgang Schaeuble said on May 4 that the mechanism shouldn’t be allowed to recapitalize Spanish banks directly.