The options are clear: Spain’s troubled banks seek fresh capital themselves, the government comes to their aid or euro zone funds are somehow pushed in their direction.

The problem is the banks are in no shape to attract investment, Madrid cannot offer much more help since a domestic bailout would worsen Spain’s already parlous debt position, while Brussels rules out direct euro zone aid to banks.

Standard & Poor’s cut Spain’s rating by two notches to BBB+ late on Thursday, citing a budget deficit which is not falling as fast as planned and “the increasing likelihood that the government will need to provide further fiscal support to the banking sector”.

Italian officials have pointed the finger of blame at Spain, whose borrowing costs have soared since Prime Minister Mariano Rajoy ripped up a 2012 budget deficit target agreed with Brussels.

A burst property bubble and a deepening recession have made it likely Spanish banks will need more money than previously thought to recapitalize.

Left unchecked, the hole could push Spain towards a Greek style bailout which the euro zone can barely afford.

Latest data show Spanish banks are carrying their biggest burden of bad loans since 1994.

As the economy deteriorates, compounding households’ problems in repaying debt, they are expected to need more than the extra 53.8 billion euros ($71 billion) the Bank of Spain has predicted.

The companyestimates that banks have 10 billion euros left to cover asset sale losses out of the 13 billion euros raised.

“It’s evident they are short of capital,” said Andrew Lim, analyst at Espirito Santo in London.

Lim said the 53.8 billion euros buffer covers real estate loans alone, and estimated more than 100 billion euros more could be needed to provide for other loans on its books that could go bad.

The new concern is they are refinancing too many business and consumer loans which will inevitably turn sour, in order to avoid taking a hit in the near term.

“It’s a moving target as the economy contracts, but any guesstimate probably shows losses will rise,” said Hank Calenti, credit analyst at Societe Generale, which sees a need for 70 billion euros in provisions, and that assumes no acceleration of the economic downturn.

Government and financial sources told Reuters this week that Madrid will force banks to move all their real estate assets into a special holding company within weeks, although details of the scheme are still being worked on.

Thegovernment helped cover bank losses after the sale of more than70 billion euros of assets to the National Asset ManagementAgency, the country’s so called bad bank.

Buyers will not be tempted unless they get guarantees to cover future losses from rotten real estate assets and the government wants the banks to replenish the fund.

One option would be to issue bonds against future bank contributions but that would be putting further burdens on a financial sector that can ill afford them.

Tristan Cooper, Sovereign Debt Analyst at Fidelity Worldwide Investment, contrasted Madrid’s approach with that of Ireland, which took a huge hit up front, although Madrid has pumped something like 18 billion euros into its banks.

By value,late or restructured loans account for some 17.6 percent of the113.5 billion euros of Irish private residential mortgages andthe amount is set to increase, according to the Central Bank.

“Spain has chosen a softer approach, asking the banks to clear up their own mess before the government pumps in cash. We may have reached the end of the road on that one,” he said.

As Ireland seeks to make a full return to internationalcredit markets by the middle of next year, the government maynot want to spook international investors by forcing banks tofind more capital if needed.

“A decision point on bank support is approaching fast and this could involve asking the EU for help.”.

Ratings downgrades could accelerate that process by pushing up the cost of funding, for the government and the banks.

Spanish 10 year yields broke above the pivotal six percent level again on Friday, following S&P’s action.

“The rating matters. That can be a factor that may push Spain closer to external help,” said Antonio Garcia Pascual at Barclays Capital.

Economy Secretary Fernando Jimenez Latorre stuck to the script, ruling out any use of EU funds to bail out the sector, saying Spain had enough capacity of its own and that any call on public funds would be “very limited”.

The option which would save most face – allowing the Spanish government to avoid the stigma of seeking outside assistance as Greece, Ireland and Portugal have – would be for the currency zone’s rescue funds to directly recapitalize banks.

However, euro zone officials say the currency bloc is unlikely to allow the ESM, the permanent 500 billion euro bailout fund that is to come online in July, to do so.

BUDAPEST (Reuters) – Hungary’s new loan from the EU and International Monetary Fund will probably be smaller than the 20 billion euro ($26.4 billion) package that saved it from collapse in 2008, according to a senior government lawmaker, the first indication of how much Budapest will seek.

“Some people have this bee in their bonnet, but only on a personal basis. It will not happen,” a senior euro zone official said, a refusal echoed by EU Economic and Monetary Affairs Commissioner Olli Rehn in a Reuters interview last week.

Important institutions of the EU include the European Commission, the Council of the European Union, the European Council, the Court of Justice of the European Union, and the European Central Bank.

But that is a mechanism to thwart future, not existing, crises as it will require banks to pay into it, taking time to build up to a critical mass.

All that leads some analysts to think the Spanish government will have to prop up its banks, regardless of the impact on its debt cutting drive.

“The government must come out soon to say how they will address them,” said Gilles Moec, an economist with Deutsche Bank.

The central bank earmarked 9billion euros for a worst case scenario of mortgage losses overthree years, equal to 9.2 percent of all the Irish home loansheld by the banks.

At the end of 2011, Irish banks held just 895 owner occupied homes, equivalent to 0.12 percent of loans in arrears,according to the Central Bank.

“Although liquidity positions have improved and ECB long term funding brings a reprieve, Spanish banks need to continue to build their capital buffers so that they can freely access private funding markets,” the International Monetary Fund said this week.

There is also, if ECB policymakers are to be believed, little prospect of them launching a new round of money creation.

Santander took $1.3 billion of further losses on property assets this week while BBVA, said it would write down property investments later in the year.

The cost of buying protection against a default on bonds issued by Spain’s biggest two banks has risen.

As ever with the euro zone debt crisis, doing nothing is not an option.

“Given the harsh austerity measures being imposed, the likelihood of a further bursting of the property bubble and the precarious situation of the country’s overleveraged banks, it seems unlikely that the end of Spain’s woes is anywhere near,” said Stefan Angele, Head of Investment Management, Swiss & Global Asset Management.

“It may ultimately require a euro zone solution that is much bigger and more wrenching than the process in Greece.”.

($1 = 0.7559 euros)(Additional reporting by Julien Toyer, Fiona Ortiz, Steve Slater, Chris Velacott and Sinead Cruise; Writing by Mike Peacock; Editing by Giles Elgood).

Steve Branson is a business journalist based in London, UK. Steve has a passion for financial markets and breaking news stories and loves writing about business news, stock market, and economic opinions that matters most to its audience. Steve spends a lot of time discovering and researching latest financial markets and industry news stories in order to make sure the latest and greatest stories are brought to you first on BigBoardNews.com.