UPDATE 3-Austria bites Hypo bad bank bullet as lenders back out
* Government scraps plan to have lenders support "bad bank"
* Next-best option would be state-run wind-down vehicle
* Finance minister, central bank head at odds on insolvency
* FMA calls letting Hypo go bust "incalculable adventure" (Adds comments from finance minister, central bank chief)
VIENNA, Feb 10 (Reuters) - Austria scrapped its plan to have healthy commercial lenders back a "bad bank" for toxic assets at nationalised Hypo Alpe Adria and will look now at creating its own wind-down vehicle, which would increase state debt, officials said.
Resistance from other banks and problems with setting up a bad bank in a way that would keep its debt off state books under European rules scuppered the plan, Finance Minister Michael Spindelegger said after a high-level meeting at the chancellery on Monday.
"It became clear that this bank involvement and privatisation model de facto is not possible," Spindelegger said, ditching the option of bringing in lenders like Erste Group, Raiffeisen or Unicredit's Bank Austria.
He told reporters that letting Hypo go bust remained an option if all else failed. The central bank and FMA markets watchdog vehemently rejected that move, saying it posed too great a risk of sweeping Austria itself up in the contagion.
The least bad option now is considered the creation of a state vehicle absorbing up to 19 billion euros ($26 billion) in assets from Hypo. That would relieve the bank's chronic need for capital, which is a drain on state finances.
Hypo has got 4.8 billion euros in state aid since being nationalised in 2009. It was taken over to avoid a collapse whose consequences would have been felt through the southeastern European region, where it had expanded at breakneck speed.
Just how much a state bad bank would cost was not immediately clear.
Officials have estimated such a step could boost state debt as a percentage of economic output by 5 or 6 points, to near the 80 percent level that sets off alarm bells at ratings agencies.
But it would mirror the tested model that neighbour Germany adopted to wind down its ailing banks.
"If done quickly, this is a clean and transparent solution," said Austrian National Bank Governor Ewald Nowotny. Financial markets, European regulators and ratings agencies should handle it well, he said.
"In Germany it was the same. State debt of course clearly rose temporarily and then was consistently brought down. That is the second part that is important for us," he told reporters after attending the talks at the chancellery.
Asked about the impact on spreads for Austrian state debt over benchmark German Bunds, he said: "I assume that they will certainly not go up, because for the ratings agencies this is not a new problem, just greater transparency."
Austria had to nationalise Hypo after a decade of expansion, fuelled by debt guarantees from its home province of Carinthia, had pushed the bank to the brink of bankruptcy. Carinthia still guarantees around 12.5 billion euros on Hypo debt - far more than it can cover all at once - which complicates the matter considerably.
The federal government and the banks have been haggling over the problem of Hypo for about a year, closely watched by the EU competition commissioner. The central bank and the FMA markets watchdog are urging an agreement by the end of March.
The FMA warned the government earlier against letting Hypo go bust, saying it was impossible to gauge the risks and calling insolvency "an incalculable adventure".
Spindelegger refused to exclude an insolvency, the threat of which boosts Austria's leverage in negotiations with former owner BayernLB over who should pay to clean up the mess at the Klagenfurt-based lender.
"Nothing can be ruled out. We remain open for all options and the goal remains to burden taxpayers as little as possible," he said.
But Nowotny warned him not to tempt fate. "I don't think the insolvency of a province is something that a country of Austria's stature should even play with," he said.
Klaus Liebscher, a former central banker who is now Hypo chairman and heads a task force advising the government, took the same line as talk of a possible Hypo insolvency weighed on Austrian state bonds.
"I hear from investors in London, for example, that they are seriously questioning investments in Austria. That cannot be our future," he said.
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