LOS CABOS, Mexico - The European Union is working on a formula to limit the impact on Spain's public deficit of a bank rescue worth up to 100 billion euros by issuing very long loans at very low rates, a senior EU official said on Tuesday.
With the results of an independent audit of Spanish lenders expected in the next two days and a formal aid request to follow soon after, the issue will likely dominate a meeting of euro zone finance ministers in Luxembourg on Thursday.

"It will raise the deficit, but not by as much as some fear, and the markets will understand what we are doing," the official told Reuters on the sidelines of a summit of the Group of 20 industrialized and developing countries.

The bank rescue for Spain failed to banish doubts over investment risk, and the government's borrowing costs have continued to rise as the country remains at the center of the euro zone debt crisis.

The official also confirmed the debt would accumulate to Spain's debt-to-GDP ratio, but lower financing costs and a longer repayment schedule would ease the burden on the deficit.
"We will study the modalities for delivering the aid to as far as possible lessen the links between the sovereign and the banks," he added.

In a note issued last week, Eurostat, the EU statistical body, said the loan taken by the Spanish government would increase the debt while the interest expenditure would have an impact on the deficit.

Eurostat said it was too early to calculate the final cost for the deficit but explained a capital injection would have an impact only if the government covered losses at the banks and would remain harmless if the state acted as a private investor.

The Spanish authorities said they would recapitalize their lenders through direct equity stakes or through convertible bonds bearing an interest of at least 8.5 percent. In the second case, the Spanish government, which will get the EU loans at an interest rate of less than 4 percent, could make a substantial profit.

The government will determine how much each bank must take from the 100 billion euro euro zone credit line and the form in which they will receive the funds when it gets the results of the audit. (Reuters)