MADRID (Reuters) - The European Central Bank has criticised Spain's plans to use a deposit guarantee fund intended to back up savers to compensate investors in some risky bank debt for losses made when the financial sector was bailed out.
The ECB's criticism, published in an opinion document on its website, is another setback for Spanish attempts to fix a financial sector laid low by a property crash and which Madrid bailed out with European funds last year.
The country is trying to revive banking activity in order to restore credit to its recession-hit economy while restraining public spending.
While its opinion is non-binding, the ECB is one of the authorities tasked with evaluating how Spain sticks to the conditions of the 41 billion euro (35.2 billion pounds) banking rescue.
The economy ministry declined to say if it would change the plan, which was presented in March and aims to appease small-time savers caught up in the bail-out by compensating them with money from Spain's Deposit Guarantee Fund (DGF).
The ministry said in March it would ask healthy banks to stump up an extra 2 billion euros for the DGF to buy out investors holding preference shares and subordinated debt in unlisted, state-rescued banks.
Those investors, many of them small savers, were supposed to swap their hybrid securities into shares, at a loss, to contribute to the rescue - a tricky task when it came to banks that did not trade on the stock exchange.
The ECB, in the document dated April 10, said the DGF's planned purchase of shares in unlisted banks "conflicted" with the fund's core role of protecting insured deposits if a bank hits the wall.
"The ECB ... would therefore caution against amending the investment rules applying to the DGF that allow such purchases," stated the opinion letter, which is non-binding.
The ECB added that Spain should consider that banks could rebuild their capital buffers instead of contributing more to the DGF.
Deposit guarantee funds have come under scrutiny in the wake of a rescue of Cyprus in March, in which uninsured bank depositors, with savings of over 100,000 euros, lost money.
European peers, and particularly Spain, which has been at the heart of the euro zone crisis because of its gaping deficit, have rushed to reassure depositors that their savings would be insured up to the 100,000 euros mark in the event of a bailout or banking collapse, thanks to back-ups such as the DGF.
(Reporting by Sarah White and Jesus Aguado; Editing by Julien Toyer and Catherine Evans)