Six months for banks to raise capital if they fail stress tests

European banks that fail stress tests will be given six months to raise new capital before governments step in to bail them out.

The results of tests on the financial strength of 91 banks will be revealed next Friday, the European Banking Authority (EBA) announced yesterday.

But in an about-turn on promises that taxpayers would never again be required to foot the bill for rescuing failing banks, Europe's finance ministers are set to approve measures to support those that come out of the tests weakly.

Banks that are close to failing the tests will be put on a critical list in case their positions worsen.

They will be given until the end of September to make plans for strengthening their balance sheets and another three months to put their plans into action.

A document setting out the proposals, reported by Reuters, has called for capital-boosting based on private-sector measures. These include retaining earnings, selling assets, merging and raising extra equity or other high-quality capital.

But governments will be required to intervene if the plans fail. Another option is "the extreme case" of "a process of orderly restructuring and resolution" if a bank's failure threatens financial stability.

The stress tests are meant to reassure the market that potential threats to banks' survival have been uncovered and those who pass have a clean bill of health.

The EBA claims they are stricter than tests carried out last year, which gave Ireland's banks the all-clear only weeks before the country's financial system nearly collapsed and the EU and International Monetary Fund were forced to intervene.

Nomura analysts argued yesterday that the tests were credible and that the results would boost shares of major European banks.

They predicted that failures would mainly be at small, untraded banks in countries such as Greece, Portugal and Germany.

"Investor concerns have been tainted by the periphery; the core is strong and it compares favourably with the US," they said. "With debt markets already improving, we believe that benign results could catalyse a rally for [bank shares]."

The plans for government support heap more pressure on cash-strapped peripheral eurozone countries such as Italy and Portugal because they may have to bail out banks while trying to put their finances in order.

Bond futures and UK gilts rose as investors rushed for safety, while the extra cost demanded for buying Italian debt over German bonds hit a new high for the euro era.

The stress tests have caused anger and friction between European states over how to treat different securities on their balance sheets. Banks have also attacked the EBA for shifting its requirements late in the process.