Stress relief as UK's banks pass the test

Europe's financial system looks strong, say watchdogs, but its banks should not become complacent.

Just seven banks were found to have failed a 91-bank European "stress test" last night. It was conducted by the Continent's banking supervisors who gave the "big four" British banks a clean bill of health. Of the seven, five were Spanish cajas, the savings banks which have been causing concern across the continent. Greek company ATEbank and Germany's Hypo Real Estate – about which there has been concern for some time – were the other two.

They failed to achieve an aggregate tier 1 capital ratio – a measure of banks' strength and ability to withstand shocks – of at least 6 per cent in the event of the "adverse" scenario mapped out by the Committee of European Banking Supervisors (CEBS). That looked at the impact of a 3 percentage point deviation of GDP for the EU compared to the European Commission's growth forecasts over a two-year time horizon. The impact of a sovereign debt crisis was also added as part of a worst-case scenario.

Of the British banks, Barclays was shown to be the strongest by a distance. It would have a tier 1 capital ratio of 13.7 per cent – more than twice the level needed for a pass – even under the darkest scenario considered by the watchdogs.

There have been fears in the City that Barclays could be forced to break itself up if the coalition pushes ahead with plans to force a separation between retail and investment banking operations, which would mean the Government effectively carving up Britain's strongest bank.

Barclays' 13.7 per cent compares to HSBC's 10.2 per cent and 9.2 per cent for Lloyds Banking Group, which has no significant investment banking operations. Royal Bank of Scotland would have a tier 1 ratio of 11.2 per cent under the toughest scenario. However the company's strength was flattered because it is the only one of the big four protected by the Government's Asset Protection Scheme.

The combined tier 1 ratio across Europe under the adverse scenario would decrease from 10.3 per cent in 2009 to 9.2 per cent by the end of 2011. That compares to a regulatory minimum requirement of 4 per cent and the 6 per cent considered by the test. However, the CEBS noted that 38 of the tested banks were still reliant on state support.

It said: "The aggregate results suggest a rather strong resilience for the EU banking system as a whole and may appear reassuring for the banks in the exercise, but it should be emphasised that this outcome is partly due to the continued reliance on government support for a number of institutions. However, given the uncertainties over the actual path of the macroeconomic recovery, the result should not be seen as a reason for complacency."

The CEBS also said that it could not comment on the soundness – or not – of any individual country's banking system as a whole because "this question goes beyond the role and responsibilities of CEBS". The organisation said it could only be answered by individual regulators in the countries concerned.

On Britain's banking system, the Financial Services Authority said: "UK banks are well placed to handle further periods of economic stress, as outlined in the macroeconomic parameters detailed by CEBS, should such stress develop."

The watchdog put UK banks under far more stringent tests during the financial crisis.

Gavin Jenkins, analyst at Evolution Securities, said: "The long-awaited bank stress tests do not seem to have been that stressful after all. This is not surprising. The last thing the authorities would have wanted to do was to set a series of assumptions that would have led to a broad failure across the Euro area, as this could only do more damage to the already frail markets."

Mr Jenkins said the more important issue was the health of the sovereign debt markets. "Within a week I think the stress tests will be forgotten and the market will be focusing on the earnings season and economic data," he said.

The British Bankers' Association said: "UK banks have already put in the work to rebuild their businesses and put more money aside against future financial problems. It is no surprise to find they have exceeded the standards set out by CEBS to ensure banks across Europe are well placed to weather any future financial problems."