To shore up the Spanish banking system, Caja Madrid chairman Rodrigo Rato may offload a stake in a water ride inspired by the Greek god Triton, a restaurant modelled after a Roman villa and an Egyptian-themed fun house called the Piramide del Terror.

The attractions are part of a seaside amusement park called Terra Mitica that lost more than €203m since it opened in 2000 with financing from local savings banks.

Today, the park on the Mediterranean coast outside Benidorm stands as a rollercoaster-filled monument to the politically-driven lending spree that helped push some of Spain's savings banks to require government bailouts – and that now threatens the country's whole economy.

The savings banks, known as cajas, have been largely controlled by representatives of regional governments, who funded construction projects to boost local economies. When Spain's property bubble burst in 2008, property values dropped by more than 20%. As of August, the country's bad bank debt had reached €102.5bn, more than Italy or Greece.

Bad loans as a proportion of total loans were 5.62% in August compared with a median of 3.2% for 22 of Europe's biggest banks.

Rato (61), was the economy minister who paved the way for Spain's adoption of the euro in 1999, helping to create some of the economic problems he's now trying to tackle. After leaving the Spanish government, Rato headed the International Monetary Fund in Washington, returning to Spain before global financial markets seized up.

Now he's managing Caja Madrid's transformation into the third-largest lender in Spain via a merger with six smaller rivals. As part of the merger, which was encouraged by the Bank of Spain, the government is lending the bank €4.5bn of capital. The sprawling group includes lenders that stretch from the Rioja wine region to the Canary Islands off the coast of Africa.

"This is an emblematic merger because of its size, and its success is of key importance to the entire financial system's health and future competitiveness," says Elena Iparraguirre, an analyst at Standard & Poor's.

Spain, one of the eurozone's fastest-growing nations as recently as 2006, is now a laggard. After creating more than half of the five million new jobs in the eurozone from 2001 to 2006, Spain has now lost more jobs than any other eurozone nation. Unemployment surged to 20.8% in September as the economy shrank for two years in a row.

Spanish lenders now pay the biggest premium ever on their debt relative to other banks in Europe. Spreads on Spanish bank bonds in euros rose to a record 166 basis points more than the average for all lender debt denominated in the currency.

The government projected a budget deficit of 9.3% of GDP in 2010, more than three times the eurozone ceiling, and growth of 1.3% in 2011. Spain is trying to trim that in part by slicing state workers' wages – and potentially slowing the economy.

The Bank of Spain, concerned about mounting bad debts at the savings banks, has been urging lenders to combine. The country's 45 savings banks will be reduced to 18 through 13 different mergers, according to the central bank.

"It's clearly very necessary to repair the savings banks but the process raises some doubts in my mind," says Eduardo Martinez-Abascal, a professor of financial management at IESE business school in Barcelona. "How is it possible to merge three, four or even seven bad cajas and come up with one healthy one?"

Risky loans and investments are among the hidden dangers that could undo a recovery. Of Caja Madrid's €235.8bn of loans and property investments, the bank estimates that 18% could default, resulting in a €16bn loss.

The bank says the new capital lent by government and the €1.1bn the bank set aside in 2010 to cover losses should enable Caja Madrid to withstand the defaults. Job cuts and other savings will restore the bank to health and enable it to repay the government, Rato says.

"We clearly know what problems we have. We are tackling them and we have pushed ahead," Rato said last month.

Caja Madrid may need even more bailout money before Rato can turn it around, says Lorenzo Bernaldo de Quiros, a Spanish economist who served from 1996 to 2004 on a panel that advised Rato as economy minister.

"It's not a merger of one healthy company with a sick one; it's a merger of a very sick company with another that's critical," he says, referring to Caja Madrid and Bancaja, the two largest banks in the merger.

Bancaja's profit tumbled 32% to €170.1m in the first nine months of 2010, while Caja Madrid's profit plunged 63% to €231.6m.

But after watching the work he did bringing Spain into the euro fall apart amid the credit crunch, Rato's new role gives him a chance to repair the damage, one investment at a time.

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