SPECIAL REPORT-How Spain dumped a bad bank on the little guy

By Sonya Dowsett and Sarah White

MADRID, July 27 (Reuters) - Rodrigo Rato beamed as he rang the opening bell at the Madrid stock exchange one Wednesday last summer. The former chief of the International Monetary Fund raised a glass of champagne to the successful listing of Bankia, the bank he chaired.

But the good cheer on show that July day belied major concerns at Spain's fourth-biggest lender, concerns that other Spanish banks and most institutional investors knew about but which many small retail investors who bought the bank’s shares say they did not.

What worried the professional moneymen was Bankia's high exposure to Spain’s collapsed property sector. Their skepticism meant the bank had struggled to complete its 3.1 billion euro initial public offering, and had been forced to lean heavily on individual Spanish investors. Bankia branch managers personally touted the shares to longtime customers, offering them platinum credit cards and promising steady returns.

Just months later, Bankia collapsed after massive losses. The story of how the lender was able to pull off its share issue on the eve of its doom is one of the most remarkable in the banking and sovereign debt crises that have roiled the euro zone for almost four years.

The troubles at Bankia are a stark reminder that Europe’s woes are rooted in large part in its banks. Formed in 2010 from the merger of seven unlisted savings banks, Bankia was meant to be a symbol of Madrid’s faith in its famously conservative financial system. Instead the bank’s predicament has forced Europe to give emergency aid to Spanish banks and pushed Spain closer to a bailout itself. As in Greece and Ireland, the banking crisis is inextricably linked to the sovereign crisis.

Many Spanish investors, hundreds of whom have joined law suits against the bank, now say Bankia deliberately overstated the value of its real estate assets to lure people into investing in its IPO. Close to 400,000 ordinary Spaniards who bought Bankia shares have seen their investments all but wiped out in the turmoil following its takeover by the Spanish state in May.

Smalltime investors say they were not properly warned of the risks; some say they felt pushed into buying shares in the bank even as institutional investors avoided the listing.