* Santander, BBVA and CaixaBank seen top investors
* In talks to invest up to 700 mln euros each - source
* Move could pose contagion risks for financial system
By Sonya Dowsett and JesÃºs Aguado
MADRID, Oct 5 (Reuters) - Spain's healthy listed banks, Santander , BBVA and CaixaBank , will likely be the biggest investors in the country's "bad bank" with foreign investors steering clear, banking sources said on Friday.
The creation of the bad bank is a condition for Madrid to receive up to 100 billion euros ($130 billion) in European aid to prop up its shattered banking sector, and it is dependent on private investors for it not to impact on public debt.
Spain, the latest focal point of the euro zone debt crisis, is also inching towards seeking aid to deal with its debts.
One source close to the negotiations on the bad bank said the three biggest lenders were in talks with the government about investing around 600 million or 700 million euros each, but added the final sums could need some fine-tuning.
A senior Spanish banker did not want to confirm that talks were under way but said the participation of Spain's biggest banks was the only hope for the government to attract private investors in the scheme.
"If there are going to be private investors, it will be down that path, there's no other way," he said, adding that the prices funds were looking at - around 10 percent of book value - were too low.
Santander, BBVA and Caixabank declined to comment. The Economy Ministry and the Bank of Spain also declined to comment. BBVA said in September it was considering transferring assets and taking a stake in the bad bank.
Other banking sources said healthy banks will want to participate in the bad bank as a way of limiting a devaluation of their own real estate assets.
Any heavy discount applied to the assets to tempt in foreign investors would pull down prices across the property sector, blowing further holes in the banks' balance sheets.
"If you put an aggressive price on the assets to lure foreign investors you will immediately see a domino effect on the assets that the healthy banks hold. Obviously, the strong banks don't want that to happen," one Madrid-based banker said.
The banks will likely participate in the bad bank by depositing some of their real estate assets into the entity in return for an equity stake rather than money, the senior banker said.
"That's the game, they put in assets at the same value as the rest of the banks and they get an equity stake in the bad bank in return," he said.
The size of the bad bank and the price at which assets will be transferred is not yet decided but the equity tranche will make up about 10 percent of the bad bank, Economy Minister Luis de Guindos said on Wednesday.
Because the bad bank does not count as public debt if the state owns less than half, Spain wants private investors to make up 55 percent of the equity of the bad bank.
Assuming a size of 50 billion euros, Santander, BBVA and Caixabank would have to invest 900 billion euros each, should only those three banks invest, Mediobanca said in a note on Friday, adding it would be a risky move for the country's entire financial system.
"We see a larger burden on the large banks from the bad bank as a negative, risking bringing back the contagion between banks and the sovereign," Mediobanca said in the note.
A majority participation of these lenders in the bad bank would also continue the trend of the healthy Spanish banks supporting the state.
Spain's banks not only continue to buy the country's debt but they've also participated in operations like the ill-fated listing of troubled lender Bankia where they made up the overwhelming majority of subscribers to the institutional tranche.
This backing, however, is not unanimous.
The chairman of one of Spain's healthiest banks, the Basque lender Kutxabank, said on Friday it was "unthinkable" that private investors would take a stake in the short term.
"It seems to me ... to even think about private capital is an unrealistic assumption unless the price is rock-bottom," Mario Fernandez said in an interview with Cinco Dias.
($1 = 0.7689 euros)
(Editing by Julien Toyer and Hans-Juergen Peters)
Keywords: SPAIN BANKS/