Markets hold their breath as nine banks fail European stress tests

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The Independent Online

Markets remained sceptical about the stability of European banks even after unexpectedly good results in the so-called "stress tests" conducted by European regulators were published last night.

While designed to reassure investors, the tests have in the past failed to do so, and a further drain on confidence in the money markets next week, intimately connected with continuing doubts about the solvency of some eurozone nations, cannot be ruled out. The results were better than analysts had forecast, but that optimism could easily evaporate if doubts about their usefulness emerge. At its worst it could presage a second credit crunch and a return to recession.

Only eight European banks failed their tests – designed to persuade sceptical investors that they can withstand another major crisis – with a further 16 or so being graded "near-fail", out of a total of 90 examined. All the British banks passed, as did the Irish ones, now almost entirely state-owned.

Many of the weakest banks are in the distressed peripheral economies of the Euro area – in Greece and Spain in particular, but there were also failures in Germany and Austria. Spain's smaller regional banks, the cajas, have long been known to be vulnerable because of reckless lending during the property bubble earlier in the decade.

The Spanish government has attempted to fix them through a series of mergers and by injecting money. Of the 16 near fails, seven are in Spain, two are in Greece, two are in Portugal and one is in Cyprus. The failures and near failures will be required to raise more capital in the next few weeks, though by the standards of the 2008-09 crisis the sums may be relatively modest. In a joint statement Michel Barnier and Ollie Rehn, EU Commissioners for financial services and economic affairs respectively, said: "It is important that stress tests are understood for what they are: an essential piece of the puzzle, but not the whole solution, in making the whole financial sector more robust."

The European Banking Authority, based in London, published the results after European markets closed, and bank shares and the euro were subdued in trading. Yet few outside officialdom seriously believe the tests mark the end of the current crisis. Many regard them as being simply too easy.

In particular, they point out that the tests make no proper allowance for the possibility of a sovereign default by Greece or one of the other leading candidates for collapse – the very scenario that has been worrying investors for months. Turbulence after analysts digest the results over the weekend may now be expected.

Philip Shaw, an economist at Investec, said: "The single most significant issue in global markets is still the Euro area sovereign debt crisis and the question of whether Italy and Spain get dragged towards the bailout net. A lack of prompt action from Euro area finance ministers continues to aggravate the crisis." European finance ministers are due to meet at the end of next week, ostensibly to discuss the EU budget, but their informal discussions will certainly centre on the latest attempts to rescue Greece and contingency plans for Italy and perhaps Spain as well, if the level of interest payments demanded by investors threatens to push them towards default.

No need to worry – or tests too easy?

This is the second time regulators have sought to reassure nervous markets by testing the vulnerability of big banks to financial troubles. The credibility of last year's tests was undermined when several Irish banks, which got the all-clear, had, within months, to be bailed out.

Banks now have to be able to show they would still have capital worth 5 per cent of their assets even if a series of disasters occurred. Crucially, the banks have also been forced to provide more detail on how much they have lent 30 European countries, amid fears the eurozone crisis could prompt another disaster in the financial sector were a government to default on its debts.

Nevertheless, banking experts are divided on the issue of whether the tests are tough enough. That only eight of 90 banks tested failed may suggest the stresses they were asked to model were not sufficiently catastrophic. If too many investors take that view, the tests may fail to reassure markets.

Banks that failed the tests now have six months in which to bring their capital up to the required levels.