LONDON—The International Monetary Fund has started discussing contingency plans for a rescue loan to Spain in the event that the country fails to find the funds needed to bail out its third-largest bank by assets, Bankia SA, BKIA.MC +0.19% people involved in the handling of the Spanish crisis said Thursday.
Both the European Union and the IMF want to avoid having to bailout Spain at all costs, the people said, but initial planning through the IMF's European department is under way given that the country is struggling to raise a €10 billion ($12.36 billion) shortfall in funds to bail out Bankia.
A three-year rescue loan for Spain could be as much as €300 billion, one person said, although any bailout could involve smaller, shorter-term loans.
"A better picture will emerge after the IMF review of the Spanish economy starting June 4," one of the people said. "But thoughts are already being discussed" within the European department. "Some say a Spanish bailout is inconceivable, but it's equally inconceivable that preparations are not being made for such an eventuality."
One of the people said it wasn't unusual for IMF area departments—made up of fund officials who put together country reviews and negotiate bailout terms—to start drafting plans that could then be presented to the IMF board if they were needed.
IMF spokesman Gerry Rice said Thursday that the fund wasn't drafting any plans for a Spanish bailout nor has Spain requested any financial support from the IMF. Mr. Rice confirmed that the IMF's review of Spain would start Monday.
An issue in any bailout of Spain, which could end up being bigger than those already agreed to for Greece, Ireland and Portugal, would be the size of the contributions made by the IMF and the EU and where those funds would come from.
"A bailout loan could stretch the resources of both the IMF and the euro zone to breaking point and raise serious questions about the purpose of the euro," another of the people said.
"Neither the IMF, nor the euro zone, can shoulder this bill with three other euro-zone bailouts in progress. The money is simply not there," a second person said.
The actual size of any potential bailout would be discussed after the review and would be calculated based on financial needs such as outstanding bond redemptions and budget-deficit forecasts, the people said. A bailout would only be considered if the Spanish government fails to find any other way to recapitalize its banks, they said.
Spain needs €19 billion to rescue Bankia, but its own bank bailout fund has only about €9 billion left.
The bank, which would be effectively nationalized after the bailout, has fallen foul of Spain's property-market crash and the country's severe economic downturn.
The Spanish government has suggested it could enact the Bankia rescue by giving the bank debt certificates either from the Treasury or from Spain's bailout fund, the Fund for Orderly Bank Restructuring. Bankia would then be able to use this debt as collateral with the European Central Bank to cover its liquidity needs.
However, the ECB has signaled it was cool on such a plan, while denying it has received such a proposal from Spain.
Any plan involving Spanish government debt is also likely to be prohibitively expensive because Spanish borrowing costs have soared in recent weeks as worries mount that the government will incur more debt to prop up the domestic banking system.
The 10-year Spanish bond yield Wednesday climbed to 6.66%, its highest level so far this year, and a level some analysts consider unsustainable over the medium term. It has since eased slightly to 6.45%. The extra yield demanded by investors to hold Spanish bonds instead of haven German Bunds widened to 540 basis points, the highest level since the inception of the common-currency.
"Raising the money for Bankia through debt issuance is becoming increasingly difficult and things are not expected to change for the better going forward," the first person said. "Spain needs help for its banking sector and it needs it urgently."
The Spanish government Thursday said it has several months to raise the funds needed to rescue Bankia, betting this room for maneuver will allow it to find the right moment to raise money from the markets and to explore other funding options. However, the move only heightened concerns that Spain might need a bailout.
Spanish government officials are embarking on a flurry of diplomatic visits, with deputy Prime Minister Soraya Saenz set to meet U.S. Treasury Secretary Timothy Geithner and the International Monetary Fund's Managing Director Christine Lagarde Thursday on what the government described as a routine visit. IMF spokesman Mr. Rice said Ms. Lagarde would be discussing recent developments in Spain.
Pressure is now rising on Germany to allow banks to be bailed out directly by the European Stability Mechanism, a €500 billion emergency fund. The proposal was put forward by the EU Commission this week and was supported by European Central Bank President Mario Draghi Thursday. Germany has so far strictly opposed the idea, preferring instead that any loans agreed must go to governments, not institutions, under strict austerity conditions.
IMF Deputy Managing Director Nemat Shafik Thursday said the IMF also endorsed the proposal, saying it should be done "sooner rather than later."
With the crisis growing, even Germany's traditional backers like The Netherlands, Sweden, Finland and Austria are prepared to explore the possibility of an ESM bailout, one of the people said.
European officials are publicly acknowledging that the crisis is reaching a key point. Earlier European Commissioner for Economic and Monetary Affairs Olli Rehn said the euro zone must decisively move to slow contagion and reduce borrowing costs for its members.
"This is the case if we want to avoid a disintegration of the euro zone and instead make the euro survive and succeed for the sake of its member states," he said during a speech at an economic forum in Brussels
Greece's elections, set for June 17, are also turning out to be a key event for Spain. Officials are hoping that Greek voters choose a government that will abide with the bailout loan conditions set by the EU and IMF, which would cause borrowing costs across the euro zone to stabilize and buy Spain more time and more options, one of the people said.