The tests found that 7 of the region's 91 largest banks need to raise capital to withstand an unexpected decline in economic growth

A vast majority of European banks passed a round of stress tests meant to measure the likelihood that they could survive an economic or market calamity, regulators said on Friday last.

Questions about the way the tests were conducted, though, left at least some economists and financial analysts wondering whether the results would be enough to calm investors worried about the stability of the continent's banking system.

The tests found that seven of the region's 91 largest banks needed to raise more capital to withstand an unexpected decline in economic growth or a sharp deterioration in the perceived safety of government bonds issued by debtor nations like Greece, Portugal and Spain.

Banks that failed were Hypo Real Estate, a company based in Munich that is already owned by the government after a bailout, ATEBank of Greece and five Spanish savings banks.

Several other banks passed but so narrowly that they may face market pressure to increase reserves. That group included Postbank, one of Germany's biggest publicly traded banks, which is based in Bonn and is 25 per cent owned by Deutsche Bank.

Muted enthusiasm

Markets reacted to the test results with muted enthusiasm. European and U.S. stock indexes generally rose less than 1 per cent, although bank shares were down. The euro rose early but finished down less than a hundredth of a percentage point against the dollar.

As with similar tests of banks in the U.S. last year, though, it may take days or weeks to determine whether the tests will end banks' mistrust of one another's creditworthiness and encourage interbank lending, which is crucial to the normal functioning of the financial system and ultimately the overall economy.

Some economists said the tests excluded certain possibilities, like the effect of a debt default by Greece or another European country, calling into question its credibility.

“The overall result seems out of line with the tensions we have been observing in the financial system in the last few months,'' said Marco Annunziata, chief economist at UniCredit Group, based in Milan. “The tests are unlikely to reassure the market that transparency has been re-established or that pockets of weakness are being rapidly addressed.''

European policy makers said they refused to consider the potential effect of sovereign defaults because they would never allow them to happen.

In a compromise, banks were scheduled to detail their holdings of Greek, Spanish, Portuguese and other sovereign bonds. A report released by the European bank supervisors did not contain that information, which would resolve intense speculation about which banks were most exposed.

“Investors cannot reverse-engineer the results and apply their own assumptions,'' said Nicolas Veron, a visiting fellow at the Peterson Institute for International Economics in Washington.

He called the level of detail in the stress test report ‘disappointing'.

Rigorous tests

Bank regulators and central bankers insisted that the tests were rigorous and that fears about the stability of European banks were overblown.

“It is a very serious test,'' Franz-Christoph Zeitler, a member of the executive board of the Bundesbank, Germany's central bank, said at a news conference in Frankfurt. He called criticism of the tests ‘ premature'.

In May, money markets nearly froze as prices for Greek bonds plummeted, prompting the European Union countries and the International Monetary Fund to put up nearly $1 trillion — more than a quarter of the bloc's gross domestic product — to prevent troubled institutions from failing.

Regulators pointed to that extraordinary intervention as a reason so many banks passed the stress tests. In the U.S., 10 of the 19 banks tested were told they needed to raise a total of $75 billion in new capital.

The European Central Bank is eager to wean institutions off the almost unlimited cheap loans it has been providing since the beginning of the financial crisis, but cannot do so unless banks resume lending to one another.

In a second round due in two weeks, the tests will be expanded to bank subsidiaries, like the East European institutions owned by banks based in Vienna.

Some banks had already moved to raise capital in anticipation of the results. National Bank of Greece, which passed, said on Friday that it had sold euro 450 million, or $580 million, of 10-year bonds to bolster its regulatory capital.

“The sale process was completed within just four days, reflecting the investment community's confidence in NBG,'' the lender said.

Banca Civica, a merger of three smaller savings banks in Spain, failed. It said that before the results were released it signed an agreement with J.C. Flowers, a U.S. buyout firm, to place euro 450 million in convertible bonds.

In addition to Banca Civica, four other unlisted Spanish savings banks failed: Diada, Unnim, Espiga and CajaSur, which was bailed out by the Bank of Spain in May.

Hypo Real Estate said the stress tests had ‘limited relevance' because it was already transferring troubled assets to a so-called bad bank underwritten by the German government.

Germany's nine public sector landesbanks all passed — a result that could encourage scepticism about whether the criteria were strict enough. Many analysts regard the state-controlled landesbanks, which had billions in losses from subprime assets and other ill-advised investments, as overly susceptible to political influence and lacking a strategy to be consistently profitable.

Norddeutsche Landesbank, based in Hannover, passed narrowly, but said it would not need to raise new capital.

The four main French banks, representing 80 per cent of the banking assets in the country, passed easily.

“These results show that they remain capable of ensuring a strong financing of the economy both under the central scenario and under the highly stressed scenario,'' said Christian Noyer, Governor of the Bank of France.

To pass the tests, a bank's Tier-1 capital, a measure of reserves, could not fall below 6 per cent of assets in the face of a new recession and a sovereign debt crisis.

For the near term, the European Commission has said that troubled banks should try to recapitalize themselves by tapping private investors before turning to the state.

Publicly traded banks can lift their Tier-1 capital ratio to 6 per cent by selling new shares to investors.

They can also agree to be taken over by a stronger institution, or find a new investor like a sovereign wealth fund. That was the case, for example, in 2008 when Qatar bought shares in the British bank Barclays, allowing it to avoid a British government capital infusion and the accompanying restrictions.

In extreme situations, troubled banks could be wound down.

Authorities across Europe were clearly nervous about market reaction to the tests and delayed releasing results until after European stock markets closed. The tests were the most extensive conducted in Europe, covering 65 per cent of the total banking market and 20 countries from Ireland to Poland.

Regulators nearly tripled the number of banks participating in part because of prodding from the U.S. Treasury Secretary, Timothy F. Geithner, who had expressed concern that the European authorities did not have the sovereign debt crisis under control.

New York Times News Service

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