* Easing bad loans provisions to boost capital levels
* Economic environment could require easing of regulations
(Recasts, adds source confirmation, analyst comment)
By Judy MacInnes and Manuel Maria Ruiz
MADRID, May 22 (Reuters) - The Bank of Spain is considering easing rules on bad loan provisions to make them more appropriate to an environment of rapidly rising debt defaults, financial sources said on Friday.
The central bank has yet to make a decision on provision rules but may decide it needs to relax regulations set in place five years ago to put a brake on the country's real estate boom, which collapsed last year.
The Bank of Spain's analysis of the provisions regulations is driven more by the need to establish whether they are adequate for the current economic crisis rather than to improve bank balance sheets or boost capital, financial sources said.
"In my view, this would not mean an improvement in any bank's balance sheet ... The move is exclusively aimed at establishing whether current legislation fits the economic climate," said one financial sector source close to the matter.
Spain's banks have withstood the financial crisis better than their European peers largely thanks to stricter central bank regulation.
But analysts are in agreement that the banks' uniquely high provisions against bad debts will start to run dry unless the economy improves.
An easing up of the bad loans provisioning rules could be positive for the banks if it includes lowering the minimum level of anti-cyclical or generic provisions any bank should maintain, said Renta 4 bank analyst Nuria Alvarez said.
Banks would be able to extend the horizon for using up their generic provisions, which would be beneficial given it was clear from first quarter results all the banks are now eating into their provisions cushion, she said.
"It would be particularly positive for the savings banks - at least in the short-term - as they are using up their generic provisions at a fast rate," Alvarez said.
Some of the smaller savings banks are expected to exhaust counter-cyclical provisions by year-end and start going into loss to cover bad debts.
These institutions were more exposed than the retail banks to Spain's property sector boom and are now suffering the impact of the steep downturn.
"Relaxing the provisions regulations could be an adequate strategy if the economy recovers quickly," Caja Madrid bank analyst Javier Bernat said. "But it all depends on how quickly this happens. Maybe this approach is not the right one and the matter of bad loans provisions should be looked at on a case by case basis."
PROVISIONS CUSHION TO RUN DRY
At end-2008, total provisions for Spain's financial sector reached 44.62 billion euros, of which 25.76 billion correspond to generic provisions and the remainder to specific provisions.
Each bank establishes its own level of generic provisions in accordance with the size of its loan book and future expected bad loan levels. Specific provisions are made against bad loans which are already identified.
This year the banks will be hit by a fresh wave of bad debts -- this time from householders who have lost their jobs and cannot pay their mortgages as unemployment benefits run out.
"The next few months will tell us which banks are going to be capable of navigating the turbulent waters of managing their loan book and bad debt levels," Bernat said.
(Additional reporting by Andrew Hay; Writing by Judy MacInnes; Editing by Mike Peacock/Ruth Pitchford)