Banks, markets await European stress test results

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LONDON (AP) — Ninety-one banks. Twenty countries. One exam. So who’s going to flunk the European stress test?

Markets were on alert Friday, waiting for regulators to finally publish their investigation into the financial health of Europe’s banking sector. The goal of the tests is to allay market fears that the banks are in trouble after a global recession and the discovery that many European countries were carrying too much government debt.

Although most of the banks are expected to get the all-clear, there is a great deal of market concern that the tests are not as stringent as they should be, or even as rigorous as those in the United States a year ago.

“Given the recalcitrant and rather secretive way in which it has been prepared, the release of bank stress tests results is unlikely to be the silver bullet that guarantees a rapid normalization of the financial system,” said Marco Annunziata, chief economist at UniCredit in London.

Despite the intense market focus on the tests, little is actually known about how the London-based Committee of European Banking Supervisors (CEBS) is conducting its analysis — in marked contrast to the U.S. banking tests that demanded more than half the U.S. banks shore up their reserves.

The key unknown is what potential losses the CEBS assumes banks will have to absorb from losses on investments in government debt, notably those from Greece, Portugal and Spain — the three countries considered the most financially shaky.

What is known about the test is that the CEBS is assuming that EU economy will suffer another recession. That is significantly worse than the EU Commission’s forecasts, which predict the EU economy will grow by 1 percent this year and 1.7 percent in 2011.

The general consensus in the markets is that around 10 European banks will fail the tests no matter how they are designed, with the small Spanish savings banks — the so-called cajas — and the regional German banks —the Landesbanken — most at risk. Failing the stress test won’t mean the banks are bust, but that they will need to raise money from investors or governments.

The finances of the cajas were hit by the collapse of a Spanish construction and property boom, while the German banks made oversized bets on global financial markets before the 2008 meltdown.

Both cajas and the Landesbanken are not listed on stock markets and thus not subject to analyst scrutiny the way major banks such as Germany’s Deutsche Bank, Britain’s Barclays and France’s BNP Paribas are.

The European Union has 27 nations, but no banks from Bulgaria, the Czech Republic, Estonia, Latvia, Lithuania, Romania or Slovakia are being tested.

Banks in Switzerland weren’t included in the EU stress tests either, but the Swiss financial regulator is expected to publish the results of similar tests it has made at the same time as the EU results are released. UBS AG and Credit Suisse Group, the country’s two banking giants, will almost surely pass the Swiss tests after improving their capitalization rates and ridding themselves of billions of francs in risky holdings.

Anxiety about Europe’s banks mounted in tandem with the government debt crisis, which eventually led to euro110 billion ($142 billion) international bailout of Greece and a $1 trillion backstop for other troubled governments if they need it.

The worry was the banks were acutely exposed to government debt from the likes of Greece, especially as their finances had already been battered by the deepest recession since World War 2 and exposure to overheated markets such as the Spanish property market. Funding issues arose and many of Europe’s banks became more dependent on emergency funds from the European Central Bank for much of their day to day needs.

The U.S. stress tests are often cited as one of the reasons why the markets recovered in second quarter of last year. Even though 10 of the 19 U.S. banks assessed failed and were told they needed to raise around $75 billion, the results helped shore up confidence that the authorities were finally getting a handle on the crisis that had gripped markets in the wake of Lehman Brothers’ collapse in September 2008.

Once the European results are out and digested, investors will focus on what the failing banks to shore up their capital position — the likelihood is that governments will have to bear the cost.

“The more important aspect is what measures governments are putting or will put in place to support any institutions which fail, and whether the overall level of capital that the stress tests suggests needs to be raised actually matches what markets are assuming needs to be raised,” said Marc Ostwald, markets strategist at Monument Securities.

The euro will likely bear the initial market reaction — the results will be released after Europe’s bond and stock markets close on Friday but New York will still be open.

The euro has advanced over 10 cents since hitting a four-year low of $1.1878 in early June on a combination of easing worries over Europe’s sovereign debt crisis and concerns about the U.S. economic recovery.

The euro was trading higher Friday at $1.2945.


Associated Press writer Bradley Klapper in Geneva contributed to this report.

(This version CORRECTS number of countries to 20, explains which countries are not having banking stress tests.)