Loans that fell into arrears in August increased by 5.3 billion euros ($7 billion) from July, reaching 178 billion euros, Bank of Spain data showed on Thursday.

Non-performing loans on the books of the country's crippled banks have risen steadily since a decade-long property boom ended four years ago.

Spain's lenders are preparing to receive the first funds from a 100-billion-euro ($131.21 billion) credit line agreed with the European Union in June which is seen paving the way to a full sovereign bailout.

The property crash, after a decade of reckless lending to property developers, left banks with hundreds of billions of euros of toxic real estate assets on their balance sheets. But the rot has now spread to other areas of their books.

Spain is setting up a bad bank to siphon rotten property assets off lenders' balance sheets to recapitalise banks and free credit flow to families and businesses in an effort to alleviate a recession made worse by Europe-imposed spending cuts.

The country has opened the door to the possibility of including defunct consumer loans in the bad bank, although Economy Ministry sources said on Wednesday this would only be in the worst cases.

Bankinter (BKT.MC), the first Spanish bank to report nine month results, said bad loans as a percentage of total loans rose to 4.0 percent end-September from 3.9 percent end-June.

The bad bank will be designed to hold up to 90 billion euros of assets, but Spain expects the final size to be much smaller.

It is still not known at what price assets will be transferred to the bad bank. The price will be determined from November 19 to November 26.

($1 = 0.7621 euros)

(Reporting By Manuel Maria Ruiz; Writing by Sonya Dowsett; Editing by Paul Day/Jeremy Gaunt)

• A Permanent Economic Emergency