European Banks Urged to Bolster Reserves Following Stress Tests

European regulators said 8 of 90 banks whose tests were disclosed had failed the so-called stress tests, a vast data-crunching exercise designed to expose risk and restore confidence in the overall health of the European financial system. A ninth bank, Helaba of Germany, would have failed but refused to disclose its data. An additional 16 passed narrowly, and will be asked to take steps to “promptly” increase their resilience, for example by raising more capital, the regulators said.

Of the banks that failed, five were in Spain, two in Greece and one in Austria, said the European Banking Authority, which conducted the tests.

All were relatively small players. But the stress test results could also put pressure on some giant banks that have been regarded as healthy, including Deutsche Bank in Germany, UniCredit in Italy, and Société Générale in France. Capital reserves at all three were uncomfortably close to the level where they would have formally been asked to raise more capital or reduce risk.

The test results arrive amid acute anxiety that Greece is on the verge of defaulting on its debt, an event that could provoke a banking crisis because so much of those bonds are parked on the balance sheets of European financial institutions. As a result, the stress tests have clear implications for the overall health of the euro zone.

“To me the real question is not stress in the institutions but the ability of states to control the sovereign debt” problem, Paolo Bordogna, head of financial services in Europe for the consulting firm Bain Co., said ahead of release of the results.

Analysts have been skeptical that the tests this year were rigorous enough to clear up doubts about the European banking system — and to encourage institutions to begin lending to each other again rather than relying on the European Central Bank for funds.

The European Banking Authority, or E.B.A., did not examine what would happen if Greece defaults, for example, which critics saw as a major flaw.

“This year’s tests still did not include the impact of a formal debt default by a European government, which is the single greatest risk facing the European banking sector at present,” Marie Diron, an economist who advises the consulting firm Ernst Young, wrote in a note. “The publication of these results will not assuage investors’ fears over the resilience of the E.U. banking sector,” she wrote, referring to the European Union.

But European officials argued that, even if people thought the test was too forgiving, they now had a huge amount of data they could use to run their own stress evaluations, including detailed information on bank holdings of government debt.

“We are putting out a lot of information so that investors and analysts can make up their own minds,” Andrea Enria, the chairman of the E.B.A., said by telephone. Mr. Enria defended the integrity of the stress test. It imagined that banks had to absorb a sharp recession and surge in unemployment, which implied banking losses that were twice as high as in 2009, the height of the financial crisis, he said.

The E.B.A. said that at the end of last year, 20 banks would have failed the test. But in the first four months of this year, banks raised about €50 billion, or $71 billion, in new capital.

Seven banks in Greece, Germany and Spain failed the tests last year and several others came close. But unlike the tests this year, there was no requirement for those that squeaked by to raise capital, just market pressure. The regulators argue that, since then, many banks have raised money, gotten rid of risky assets or taken other steps to become stronger, so that the fail rate this year is a sign of a stricter test.

The banks that failed or passed narrowly must now seek more capital from markets or governments. In extreme cases, they may have to be sold to other institutions or wound down.

Article source: http://www.nytimes.com/2011/07/16/business/global/european-banks-urged-to-bolster-reserves-following-stress-tests.html?partner=rss&emc=rss