(Reuters) - Mounting bad loans, competition for funds and exposure to wobbly Portugal make Spain's banks a potential liability as the country fights to avoid an Ireland-style bailout.
A burst property bubble also weighs on the sector, but the immediate worry is over the spring of next year when both the banks and the government will be in the market for a combined 50 billion euros ($66 billion) of funding.
"Problems may well arise when banks need to turn over debt at the same time as the government if confidence remains low," said Javier Bernat, analyst at Caja Madrid.
A wave of consolidation and conservative rules have supported the banks so far, but after Ireland accepted an 85 billion euro aid package, investors are turning their eyes to Portugal and Spain.
In the larger economy, mid-size banks such as Banco Sabadell
and Banco Pastor are seen as potentially the most vulnerable.
They were frozen out of European interbank markets earlier this year, and are not as diversified as global giants BBVA and Santander.
Capital requirements for Spanish banks have traditionally been more stringent than in other countries and the average core Tier 1 capital of the sector was 7.7 percent under a crisis scenario in July's Europe-wide stress tests.
But the bar has been raised for all banks since then, as new capital rules have been agreed, leaving Spanish banks looking less well capitalized than many international rivals.
The weakest link in Spain's banking system are regionally focused savings banks -- who had an average core Tier 1 capital ratio of only 5.5 percent in the stress tests. They have already gone through a forced consolidation process that has cost the government 15 billion euros in credit lines.
Shares in Santander, the euro zone's biggest bank, sagged 3 percent to an 18-month low on Tuesday as worries about the sector grew.
Spain's economy is larger than those of fellow euro zone peripheral countries Ireland, Greece and Portugal combined, and if it spirals into a debt crisis despite progress cutting its budget deficit, a bailout would strain the European Union's safety net.
With the economy stagnant and spending cuts landing, market jitters over possible bank funding problems have pushed up financing costs for Spain to euro-zone lifetime highs of about 5.4 percent for 10-year sovereign bonds.
Another source of concern is heavy exposure to Portugal, which is seen as the next euro zone trouble spot. Spanish banks had a $108 billion exposure to Portugal at the end of March, according to Bank of International Settlements data.