Eight European banks have failed a test of their ability to withstand a prolonged recession which did not build in the impact of a Greek default, the European Banking Authority said on Friday.The watchdog's "stress test," which made 90 lenders reveal for the first time their profit forecasts, a breakdown of their sovereign bond holdings and funding costs, showed the failed banks would need 2.5 billion euros ($3.5 billion US) in fresh capital, way below what most analysts had expected.
Five banks in Spain, two in Greece and one in Austria flunked the test. Expectations were for five to 15 banks to fall short and need to raise 10 billion euros or more in capital.
The euro hit a session high versus the dollar and safe-haven U.S. Treasury bonds pared gains in response.
"With only eight banks failing and the requirement for these banks to raise 2.5 billion in capital, it wasn't the solution to restore confidence. What was needed was for more banks to fail and for more capital to ultimately be raised," said Michael Symonds, credit analyst at Daiwa Capital Markets in London.
Banks were deemed to have failed if they slid below a 5 percent core capital pass mark in the face of a theoretical slide in stock, bond and property prices during a two-year recession.
A further 16 banks passed the 5 percent mark by less than one percentage point and will also have to take action.
"The EBA has also recommended that national supervisory authorities request all banks whose core Tier 1 ratio is above but close to 5 percent, and which have sizeable exposures to sovereigns under stress, to take specific steps to strengthen their capital position," it said in a statement.
Failed banks must now produce firm plans by September to plug capital shortfalls by the year-end, with their home government ready to step in with taxpayers' money if needed. Lenders that scrape through the test will also be expected to shore up their capital buffers.
WHAT ABOUT GREECE?
Critics say the health check failed to reflect market expectations that Greece will default on its debt in some form, which would pile up losses for German and French banks that hold large amounts of the country's debt.
The EBA did not force banks to explicitly haircut sovereign bonds held in their long-term banking book, but told them to include the estimated hit of potential losses from holdings based on a theoretical four notch credit rating downgrade, which would mean a low rate country like Greece had defaulted.
Under the test, banks would take a 15 percent "haircut" on Greek bond holdings, while most market experts expect to see up to half the value of those bonds wiped out at some point.
Fears the Greek crisis will spread to Spain and Italy have caused a jump in borrowing costs for those countries and their banks, prompting concern lenders are not resilient enough to cope with potential losses if the crisis deepens. European banking shares have slid to two-year lows as a result.
This is the third and toughest test of lenders in the European Union since the global financial crisis, which began four years ago—last year's gave Irish banks a clean bill of health shortly before they collapsed into state control.
Some banks moved to bolster capital ahead of the results, though it is too late to affect them.
Austria's Volksbanken, which failed the test, sold its eastern European arm VBI to Russia's Sberbank on Thursday.
Greece's EFG Eurobank said it was in talks to sell a majority stake in its Turkish unit Eurobank Tekfen, and Greek peer Piraeus said it was trying to sell its Egyptian business to Standard Chartered.
Greek banks are under severe pressure to strengthen their capital to cope with the economic crisis at home.
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