Spain has gone back into recession, as the government pressed ahead with unpopular spending cuts to rein in burgeoning debt.

Spain's economy shrank by 0.3% for the second quarter in a row in the the first three months of 2012.

This is according to preliminary data by the National Statistics Institute.

The return to recession, blamed on weak domestic demand only partially compensated by exports, comes barely two years after Spain emerged from the last downturn at the start of 2010.

It was no surprise coming days after an even more pessimistic diagnosis by the Bank of Spain, which predicted the economy would shrink by 0.4% in the first quarter. But it was the first official estimate to confirm a recession - two quarters of shrinking economic output.

Despite the recession and a towering unemployment rate, which hit 24.4% in the first quarter, the government has vowed to meet its ambitious deficit-cutting targets so as to regain market confidence.

Tens of thousands of people took the streets on Sunday to protest against the conservative Popular Party's spending cuts, however, especially in health care and education.

Across the euro zone, meanwhile, the emphasis on austerity remedies during a recession is increasingly come under question. Investors' doubts about Spain's ability to meet its deficit goals are amplified by the plight of Spain's banks, many bogged down in bad loans extended during the property boom.

Markets fear the state may have to step in to help some banks' fragile balance sheets, placing its own deficit under further stress.

Standard & Poor's earlier today downgraded the ratings of the top Spanish banks, including Santander and BBVA, after slashing the country's credit standing because of the deficit and the recession.

The banks affected include Santander and its subsidiary Banesto, BBVA, Banco Sabadell, Ibercaja, Kutxabank, Banca Civica, Bankinter and the local unit of Barclays.

S&P on Friday slashed Spain's sovereign rating by two notches to 'BBB+' and said today that the same considerations "could have potentially negative implications for our view of the economic risk and industry risk affecting the Spanish banking industry."

Spain mulls hiving off bank bad loans

Spain's government said today it is studying a scheme to remove the massive weight of bad property-related loans crushing the banking sector.

The proposed solution would allow banks to split off their bad loans and place them into a separate agency, an Economy Ministry official told AFP, speaking on condition of anonymity.

The agency would not be a 'bad bank' - a special vehicle used in other countries to help stabilise the banking system and the economy - because the state itself would take no part, the official said.

Banks who joined the scheme would have to set aside financial provisions that recognise the sharply reduced market value of the loans, extended during a huge property bubble that imploded in 2008.

"What we are speaking about is a type of agency where several banks could come together or one could do it perhaps with an outside partner, so they can externalise their property assets," the official said.

"It is so banks can go back to doing their work as banks and someone else can take care of selling the assets. "Conditions will be imposed and one of them will be that the banks have to make the requisite provisions for those assets. We think that the provisions should be close to the market value of the assets," the source added.

The state would not take part but foreign investors could be invited to join, the official said. "It is an idea we are considering, one possibility," the source stressed.

Bank of Spain figures on Friday showed commercial banks held problem property loans worth €184 billion, some 60% of their property portfolio at the end of 2011.

Central bank figures show that the ratio of bad loans - those at least three months in arrears - hit an 18-year high in February of 8.15% of total credit extended, the highest since 1994.

Another financial source close to the matter, also speaking on condition of anonymity, said the study was "still a bit green. "They are looking at what is the most appropriate solution to remove the property assets from the banks' balance sheets," the source said.

The conservative daily El Mundo said the Bank of Spain had appointed BlackRock's Financial Markets Advisory division and management consults Oliver Wyman as advisors on cleaning up Spanish banks' balance sheets. BlackRock had helped to design Ireland's National Asset Management Agency which took over the banking sector's bad debt as part of a wider bail-out for Ireland, the newspaper noted.