The flames of the eurozone crisis leapt higher yesterday, as fears spread about the state of the Continent's most vulnerable banks.
Shares in the Spanish lender, Bankia, plummeted 30 per cent at one stage in trading, following a report that customers had withdrawn €1bn in deposits since the Madrid government was forced to part-nationalise the bank last week.
Bankia released a statement in the afternoon saying that the deposit fall was simply a seasonal effect rather than a bank run. This served to stabilise the share price, but the lender still ended up losing 14 per cent of its value.
Market fears intensified last night when the credit rating agency Moody's downgraded 16 Spanish banks, a move likely to push up the cost of funding and further undermine confidence. Santander UK was also downgraded, but has a higher rating than its Spanish parent company.
Yesterday's Spanish panic followed a warning earlier in the week from the Greek President, Karolos Papoulias, that savers had withdrawn €700m (£560m) from Greek banks since the country's inconclusive election result on 6 May.
Markets have also been spooked by revelations that Greek banks are now unable to access certain forms of liquidity support from the European Central Bank. And last night credit ratings agency Fitch downgraded Greece to CCC from B-, the lowest possible for a country that is not in default.
The fragile European financial system has moved to the centre of the sovereign debt crisis. The dominant fear is that a Greek exit from the eurozone will prompt a series of runs on weaker banks across the Continent, stretching the resources of governments beyond breaking point and forcing nations such as Spain and Italy to seek official assistance from the eurozone and the International Monetary Fund.
The Spanish banking sector is a particular source of alarm. Analysts estimate the nation's lenders could be sitting on unrecognised bad property loans of up to €100bn. The Spanish government last week unveiled a plan to require its banks to put aside an extra €30bn against future possible losses and announced an independent audit of its lenders' balance sheets. But that was seen as inadequate to restore confidence.
Madrid has been encouraged to seek support now for its banking sector from the European bailout fund, the European Financial Stability Facility.
In Athens yesterday, a caretaker government was sworn in after the largest political parties failed to form a coalition. The interim Greek cabinet includes a former head of the army, Frangos Frangoulis, a former police chief, Eleftherios Ekonomou, and a professor of constitutional law, Antonios Manitakis.
This administration, led by senior judge Panagiotis Pikramenos, will run Greece until new elections are held on 17 June.
Opinion polls suggest Syriza, a far-left party that refuses to accept the austerity demanded of Greece by its eurozone partners and the IMF, will win the biggest share of the national vote next month. Senior European politicians have warned that, unless the next Greek government signs up to further austerity and economic reforms, Athens's bailout funds will be cut off.
This would prompt a default by Greece on its debt and an exit from the single currency.
The uncertainty over the future of the single currency hit the value of the euro. It fell to a four-month low against the dollar at €1.2730. The euro also slipped to its lowest level against the Japanese Yen since February.
In New York, in a speech to the UN, the President of the European Commission, Jose Manuel Barroso, was due to pledge support to the Greek people provided they honoured their commitments. A pre-released text of his speech said: "We want Greece to stay in the euro area and the European Union will do all it takes to ensure it... We will honour our commitments toward Greece and we expect the Greek government – current and future – to fulfil jointly agreed conditions for financial assistance." However, delivering the speech, Mr Barroso omitted any mention of Greece.
Stuart Gulliver, group chief executive of HSBC, said that there was a risk that markets would take a drastic downward lurch even before next month's Greek election. "It's absolutely how the eurozone plays out and whether Greece stays in, and/or whether firewalls are high enough to protect Spain and frankly whether markets take things into their own hands before 17 June," he said.