Spain's cabinet approved a major financial reform package on Friday including the creation of a "bad bank" to buy troubled property assets and bad loans from lenders.
Spain had agreed to push through the changes as a condition for receiving a banking sector rescue loan of up to €100-billion ($125-billion) from its euro zone partners.
Deputy Prime Minister Soraya Saenz de Santamaria said the financial sector reform – Spain's fifth in three years – was needed to get credit flowing again to the economy.
"We must clean up the financial sector to have banks lending again," she told a news conference.
"With this reform, we respect our European commitments," she said.
Spanish banks have been weighed down with rising bad loans and repossessed real estate since the collapse of a property bubble in 2008, which sent the jobless rate soaring to nearly 25 per cent.
The "bad bank" will last for 10 to 15 years and it will buy an as-yet undetermined amount of bad loans and foreclosed property from lenders that receive euro zone aid, Economy Minister Luis de Guindos said.
Spanish banks will receive cash, debt or shares in return for toxic assets transferred to the "bad bank," he added.
The latest reform forces banks to strengthen their balance sheets by raising the ratio of rock-solid core capital to 9 per cent of total assets from 8 per cent.
The legislation also makes it easier for the government to take control of troubled lenders.
"We are establishing the basis so that there will never be another crisis such as this one ever again," the economy minister said.
The Spanish cabinet was set to approve the banking reform last week but the the European Commission asked Madrid for a one-week delay to give it time to analyze the text.