Trouble is, its hopes of avoiding having to pump in billions of euros of public funds to counter the impact of the bombed-out property sector may be dashed because of the scale of the banks' problems.

Four years after the start of the property crash, lenders are still harboring billions of euros of unsellable property and impaired loans to developers. And some analysts say fixing the sector will likely need some kind of external financial injection in the form of state cash or European Union aid.

Assurances no public money will be used to bail out lenders may thus come back to haunt the government and undermine its credentials for sound economic management.

The government wants banks to stump up around 50 billion euros ($66 billion) of extra provisions themselves, with strong banks such as BBVA, CaixaBank and Santander stepping in to absorb weaker players.

Critics say banks which are highly exposed to the real estate sector will still be short of capital. Cash is also needed to provide loss guarantees and tempt bigger banks to buy up weaker players.

"It is not clear how some of the domestic banks will be able to close the capital shortfall by themselves," Nomura analyst Daragh Quinn said. "It is not unrealistic to think some external aid is going to be needed."

Bankia -- the result of the merger of seven unlisted regional banks -- has one of the highest exposures to real estate, with 41 billion euros in developer loans and 11 billion euros in foreclosed property on its books.

A high-ranking government source stressed on Friday the banks would shoulder the burden of recapitalizing the sector.

The Bank of Spain says around half of banks' exposure to the real estate sector is problematic -- equivalent to 176 billion euros of foreclosed property and unrecoverable loans. Around 33 percent of those assets, i.e. 58 billion, have already been provisioned for, the central bank said.

GAME OF DARE

Increasing that provisioning on repossessed assets alone to 55 percent would imply 20 billion euros of additional provisions for listed banks, JP Morgan says. That does not include the unlisted regional banks, or cajas, many of which lent recklessly to developers during the property boom.

Banks have already had to increase their contributions to the Deposit Guarantee Fund -- the vehicle that was practically used up in bailing out troubled Alicante-based savings bank CAM in a 5.2 billion euro rescue.

One option could be for the government to lend cash to this vehicle to recapitalize banks, or encourage mergers. Loans rather than a direct donation would sidestep the politically sensitive issue of using public money to rescue banks.

Another possibility is for the European Union to step in via the European Stability Facility (EFSF), although any entry of European money would be politically negative for the government as it would look like a bank bailout.

"I believe they are exploring the possibility of obtaining financing from Europe, looking at the costs and conditions attached," a legal source said.

The hope that stronger banks will step in to take over weaker players without generous guarantee schemes looks farfetched, market players say.

The state auction of insolvent savings bank CAM attracted just one bidder, mid-sized bank Sabadell, despite hefty guarantees against future losses.

However, hefty bank insolvencies are not good for any Spanish bank, and stronger lenders may feel the need to step in to take over insolvent players in order to prevent any further damage to the sector, one analyst said.

"It is like a game of dare -- the banks do not want to take them on, the government does not want to take them on," said one London-based analyst.

"The best way to do it is for both to share the bailout, getting a private bank to take troubled ones over so that they save face and then the government takes on some of the losses."

(Additional reporting by Fiona Ortiz; Editing by David Holmes)

By Sonya Dowsett