Miguel Angel Ordoñez, the Bank of Spain’s governor, told the Spanish parliament yesterday that the country’s financial system was “immensely solid” despite the dramatic fall in the share price of mid-sized banks and construction firms geared to the deflating property bubble.

“The current turbulence has highlighted the downside risks to growth but Spanish institutions face this episode from strength. Exposure to [sub-prime debt] is insignificant: the problem is we don’t know where the losses are, or who owns what,” he said. “The biggest favour the banks can do is to come clean on losses.”

The central bank also denied reports that its financial institutions had required “emergency liquidity” along the lines of Northern Rock, but the statement failed to end doubts since Spanish banks have been able to borrow unlimited sums cheaply from the European Central Bank’s window.

David Taguas, the prime minister’s chief economic adviser, said: “To talk about severe adjustments or a meltdown in prices is ridiculous. That sort of crisis is unthinkable. We have…one of the most efficient financial systems in the world. That’s insurance in times of turbulence.”

The reactions follow a scathing report on the Spanish banks by Citigroup that sent tremors through the Madrid bourse. The note downgraded Banco Popular, Banco Sabadell, Banesto and Bankinter, warning the credit crunch had changed the picture for Spanish lenders that rely on the wholesale capital markets. It was exactly this sort of funding that caused Northern Rock’s troubles. The Spanish banks’ shares have fallen almost 40pc since April.

“Spain’s mid-cap banks have some of Europe’s lowest core capital ratios (6.12pc) and the highest loan-to-deposit ratios (182pc). The freeze in credit markets reverses all the prior positives for investing in these cap banks,” said Kato Mukuru, the note’s author.

He added the debt-driven M&A deals that enriched these banks are likely to become rarer in the new climate, while a mismatch of maturities would eat into profit margins. The banks rely on three-month paper to raise funds, but their assets are on a 12-month cycle.

Adding to the woes, the spreads on Spanish AA mortgage bonds have leapt from 21 to 100 basis points over Euribor.

The banks are highly exposed to the Spanish housing market. After rising 270pc since 1995, house prices have begun to fall in parts of northern Spain, slipping 2.1pc in Barcelona and Madrid so far this year. Over 98pc of all mortgages are priced off floating Libor rates, causing mortgage payments to almost double in under two years. Construction has reached 18pc of GDP, more than Germany (15pc) at the height of the reunification boom.

David Owen, an economist at Dresdner Kleinwort, said Spain was in danger of a serious crisis. “House prices may fall, but what is even worse is that the corporate sector’s deficit has grown so large that it needs to find financing equivalent to 10pc of GDP every quarter just to stand still,” he said.

“In an environment of easy credit and low rates, these excesses are not an issue, but it can quickly unravel as the mood changes. The problem is that a country inside EMU can’t get itself out once it reaches tipping point: it can’t cut interest rates or let the currency fall.”

While the extreme levels of household debt in Spain are similar to those in Britain, the abilities of the two countries to act in a crisis are quite different. Spain may face a replay of Britain’s ERM crisis in 1992, but this time without the safety valve of easy exit.

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The Bank of England has caved into pressure from the Financial Services Authority, bankers and its political masters by flooding the capital markets with £10bn of three-month money and widening the asset classes it will accept as collateral against the loans.

Financiers have been calling for the Bank to relieve pressure in the three month inter-bank lending market for weeks but, earlier this month, Governor Mervyn King expressly stated that the problems were not the Bank's concern, saying: "The source of these problems does not lie in a lack of central bank liquidity."

In a humiliating climbdown, it said it is now acting "in order to alleviate the strains in the longer-maturity money markets". The measures taken are to "provide funds at a three-month maturity against a wider range of collateral, including mortgage collateral, than in the Bank's weekly open market operations".

The decision to widen the asset class comes amid reports that the FSA has been urging the Bank to take just such action and pile the pressure on Mr King, who faces a grilling by the Treasury Select Committee tomorrow over his handling of the credit crisis.

The Bank is believed to have been against the move, leading to tensions between the two regulators. The Chancellor is also thought to have urged the Bank to take action in the three-month market following the Treasury's intervention in the Northern Rock crisis.

Financiers claim that, had the three month money been made available earlier, Northern Rock may not have resorted to the Bank's emergency facility that has panicked customers, irreparably tarnished its reputation and caused the share price to halve.

Matthew Sharratt, an economist at Bank of America, said: "One can only say that it does represent something of a U-turn. It's likely that the pressure on money markets would have been considerably less had this policy been undertaken a couple of weeks ago."

Widening the asset class will allow banks to use assets such as mortgages as collateral to draw down on the £10bn facility. Financiers believe the move is important as it demonstrates confidence in the banks and their assets, which may help restore faith across the market. The move will also allows banks to refinance loans that might otherwise be tying up much-needed capital.

The Bank said the first £10bn auction will be next week, "and three further auctions will be held at weekly intervals... the size of future auctions will be decided in due course". It will charge interest at 6.75pc on the loans.

By widening the accepted collateral class, the Bank is following in the footsteps of the US Federal Reserve and the European Central Bank. However, financiers said it may have been too little too late. The Fed decision to cut rates by half a percentage point yesterday has already relieved pressure on the three month inter-bank market.

Inter-bank lending rates had already dropped this morning, from 6.14pc to 5.88pc in the overnight market and from 6.75pc to 6.55pc in the three month market. Because three month money is now cheaper in the inter bank market than the Bank's 6.75pc penal rate, financiers said the facility may not be used unless the "wider range of collateral" includes lower-quality mortgage assets.

One banker said: "You can fund good quality paper at less than that at the moment, but this will have the effect of capping the three month lending rate at 6.75pc. This will only be attractive if the Bank accepts weaker assets as collateral or if they lower the rate."

He added that the City was looking for more detail on exactly what quality of "mortgage collateral" will be accepted. The Bank will provide the information on Friday.