Ratings agency Moody's Investors Services downgraded 16 Spanish banks Thursday, the same day as the government of Spain denied rumours customers had moved to take their deposits out of a bank it recently nationalized.

Moody's cut by one to three notches, citing an increase in bad loans held by the banks.

Moody's also said it cut because it believes the Spanish government's ability to provide support for five of the banks has been reduced.

Shares in Bankia fell as much at 29 per cent after the newspaper El Mundo said depositors have withdrawn more than €1 billion ($1.29 billion Cdn) since the state took it over a week ago.

Its stock closed down 14 per cent.

Bankia, Spain's fourth-largest lender, insisted its depositors' money was safe and that deposit flows in and out of the bank in the first half of May were "essentially of a seasonal nature."

The government denied there was a run on the bank.

"It is not true that at this time a flight of deposits from Bankia is taking place," said Fernando Jimenez Latorre, the deputy economy minister, adding that the bank was big and "has enormous strength."

The euro was also down, dipping 0.3 per cent to 1.27 US late in the afternoon, as Spain paid sharply higher interest rates in a debt auction, reflecting concerns the country will be caught up in the fallout of the Greek crisis.

"It is again the same story as Greek uncertainty dominates the market, causing very volatile trading conditions and adding further pressure to the euro," said a commentary from Sucden Financial in London.

And there was no improvement in the turmoil in Greece, where a caretaker cabinet was sworn in Thursday and will lead the country into an election on June 17, after a deadlocked vote on May 6 sparked more political stalemate and brought the country's continued use of the euro currency into question.

Spanish yields approach 7%

The Spanish government paid 4.87 per cent to borrow for three years, compared with 4.04 per cent on May 3.

Spanish 10-year bonds were trading on the markets at a high of 6.32 per cent, a sharp increase from below five percent in March.

It was when their bond yields reached seven per cent that Greece, Ireland and Portugal sought bailouts.

The jump in yields pushed U.S. stocks to close at a four-month low.

The Dow Jones industrial average fell 156.06 points, or 1.24 percent, to end at 12,442.49. The Standard & Poor's 500 Index was down 19.94 points, or 1.51 per cent, at 1,304.86. The Nasdaq Composite Index was down 60.35 points, or 2.10 per cent, at 2,813.69.

The Toronto Stock Exchange, heavily weighted in gold stocks, eked out a gain. The S&P/TSX rose 4.60 points to 11,330.68.

Gold for June delivery gained $38.30 to $1574.90 US an ounce.

Gold was helped by a rise in the U.S. dollar and by buying as an inflation hedge as some traders expect the deepening European crisis will lead central banks to expand bond-buying programs to stimulate growth.

The Canadian dollar closed lower at fresh four-month lows Thursday, down 0.62 of a cent to 98.13 cents US as traders moved into the relative safety of securities priced in U.S. dollars.

On Tuesday various media reported that Greek depositors withdrew €700 million ($896 million Cdn) from local banks during the week ended Monday.

The concerns about the financial sector augmented jitters about the broader country's financial future at a time when Greece's political chaos threatens to destabilize the entire European market.

Investors worry that a messy Greek exit from the currency bloc could destabilize Spain's financial sector. The concern is that the banking sector might not be able to meet tough new provisioning requirements and require bailouts if concerns about their stability worsen.

The government, meanwhile, risks requiring a bailout itself if it needs to rescue its banks. It is already struggling to meet deficit-reduction targets during a painful recession, with austerity measures draining money from the economy.

Prime Minister Mariano Rajoy warned earlier this week that the country risked being frozen out of capital markets because of the sky-high interest rates, or yields, it would have to pay to maintain its debt.

With files from The Canadian Press and The Associated Press