Seven banks fail EU stress tests

24 Jul 2010, 6:37 am   -   Source: AAP
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Out of 91 banks tested for resistance to economic upheaval, German state-owned lender Hypo Real Estate, Greece's ATEBank and five regional savings banks in Spain failed the body's key test of capital strength. (AAP)

Out of 91 banks tested for resistance to economic upheaval, German state-owned lender Hypo Real Estate, Greece's ATEBank and five regional savings banks in Spain failed the body's key test of capital strength. (AAP)

Seven European banks, mostly in Spain, have failed stress tests of their strength to withstand a crisis, but overall EU banks have been judged to be sound.

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Seven European banks, mostly in Spain, have failed European stress tests of their strength to withstand a crisis, but overall EU banks have been judged to be financially sound.

Governments are already working with the seven weakling banks, in Germany, Spain and Greece, to help them shore up their finances, The Committee of European Banking Supervisors (CEBS), which carried out the crash tests, said.

Out of 91 banks tested for resistance to economic upheaval, German state-owned lender Hypo Real Estate, Greece's ATEBank and five regional savings banks in Spain failed the body's key test of capital strength.

"This outcome was pretty much in line with expectations and the Committee of European Banking Supervisors appears to have delivered reasonably rigorous methodology in an attempt to instill confidence," said ING bank analyst Chris Turner.

"What can be said is that today's stress test release does not appear to have uncovered any 'skeletons in the closet'. Whether it goes far enough remains to be seen."

The report spared all the banks examined in Portugal, which like Greece became a focus of concern in recent months due to high public debt levels.

Greece, which sparked fears for the stability of the entire eurozone and was rescued by an EU and IMF bailout, also appeared to get off lightly with just one of its banks failing the CEBS test.

Another focus of concern in Europe, Ireland, saw its banks also pass the CEBS's key measure of so-called Tier One capital ratios, as did Italy. French banks likewise emerged with passing grades.

The Tier One ratio measures core capital against outstanding assets, such as outstanding loans. A key test was the effect a government debt crisis would have on balance sheets of banks that hold large amounts of government bonds.

Banks must maintain a minimum ratio of six per cent, while a surplus reassures investors the bank is not likely to find itself suddenly strapped for cash.

British banks Barclays, HSBC, Lloyds and RBS passed. Slovenia's biggest bank, Nova Ljubljanska Banka (NLB), scraped through with the CEBS calculating its Tier 1 ratio at 6.3 per cent.

The CEBS estimated the total potential losses to the 91 banks - which account for 65 per cent of the European banking market - at 566 billion euros ($A816.5 billion) over two years if certain tough conditions hit.

Analyst Jennifer McKeown of Capital Economics said although the tests showed the European banking sector to be basically sound, they were unlikely to allay concerns by investors, particularly as they did not take into account the possibility of a European government default.

"On the face of it, the results of the EU bank stress tests would seem to be fairly positive, but worries that the tests were not demanding enough will persist," she said.

"Any positive impact on sentiment will be limited by the fact that the tests were not particularly stringent. The 'adverse' economic scenario incorporated a return to only a very mild recession next year. What's more, the prospect of an outright sovereign default, which is what has worried markets most, has not even been considered."

According to CEBS calculations on the effect of financial difficulties on lenders' capital strength, "seven banks would see their Tier 1 capital ratios fall below six per cent," the body's key measure, it said in a statement.

"The competent national authorities are in close contact with these banks to assess the results of the test and their implications, in particular in terms of need for recapitalisation," the CEBS said.

European governments were likely to move fast to announce support for the banks that have failed the tests and can expect to face redoubled problems in raising funds normally from financial markets.

Governments could take action either directly or through national bank recapitalisation. Some banks are already being helped by exceptional measures by the European Central Bank, including the purchase of some government bonds.

The tests were intended to remove clouds of suspicion and uncertainty about the true state of many banks in Europe, and therefore the risk of a lack of confidence causing a domino effect.

It was the first time such an insight into the secret entrails of leading banks, individually and collectively, has ever been published in Europe.

If markets judge the details of the tests to have been too weak, analysts have warned that the result could be to undermine or even negate the objective of the examination.

If the criteria pass the market test, then doubts about the solvency of the European banking sector will be dispelled. Banks will step up lending among themselves and, more importantly, to businesses and the economy at large.

In general the tests were designed to show how each bank would cope if economic growth slowed sharply, if money owed were not paid, if stock markets plunged or if a crisis slashed the value of government bonds on their books.

The bottom line of the tests is how the balance sheets of the banks would look once they had been adjusted for the effects of such shocks - in other words, would they have enough capital to continue operating.

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