"We needed to see more banks fail."

"We needed to see more banks fail."

Published: July 18, 2011

The failure rate of this year’s European Union banking stress tests is “not sufficient”, an analyst has told EMEA Finance.

The core tier 1 capital ratios of eight banks in the region fell below the 5% benchmark set by the Europe Banking Authority (EBA) when the results were released this weekend. Those banks will now have to raise a combined €2.5bn to meet their capital shortfall.

“The headline number doesn’t read well,” says Michael Symonds, a credit analyst at Daiwa Capital Markets Europe. “Fundamentally, for these tests to have a positive impact, we needed to see more banks fail and a larger capital deficit identified.”

Austria’s Oestereichische Volksbank failed to meet the minimum requirements, as did Greek state-controlled banks ATEbank and EFG Eurobank. Spanish lenders Catalunya Caixa, Pastor, Unnim, Caja3 and CAM also failed.

Germany’s Landesbank Hessen-Thueringen effectively became the ninth bank to fail when it pulled out of the process days before the results were due. The bank claims it would have reported a ratio of 6.8% if the EBA had allowed it to use its silent participation, a debt-equity hybrid, as a capital reserve.

A further 16 institutions achieved a marginal pass with tier 1 ratios of between 5% and 6%. These banks, which include seven Spanish, two Greek, two Portuguese and two German lenders, have been given three months to strengthen their balance sheets.

Several of the region’s banking giants only just passed. Deutsche Bank, Société Générale, UniCredit, Commerzbank and RBS reported tier 1 ratios of between 6.3%-6.7% only.

But the results could have been worse. The benchmark set by the EBA did not reflect the Basel III accord’s minimum 7% core capital ratio. If that had been adopted, half (43) of the banks would have fallen short of the benchmark with a combined capital shortfall of €42.3bn.

Many analysts have complained that the tests were not tough enough and failed to take into account the impact of a likely default by Greece. While Greek bonds are trading at about half their face value, the EBA only required banks to assume a 15% loss on their holdings.

The EBA claims the tests were more stringent than those carried out last year, when two Irish banks received a government bailout months after passing the tests. Daiwa’s Symonds agrees that the tests have been worthwhile, with far greater level disclosure of information required by the banks this year.

But one analyst, who asked not be named, noted to EMEA Finance that the tests assessed the solvency of the banking system in a normal credit economic downturn, not in the event of haircuts in the bond markets.

“That wouldn’t be a banking sector issue – at that point it would be much bigger than that,” the analyst said. “To a certain extent the issue in the system has moved beyond just the pure banking system.”

One positive outcome of the tests has been the pressure placed on banks to bolster their finances. The tests appraised balance sheets at the end of 2010, when 20 lenders would have failed with an overall shortfall of €26.8bn. This led several lenders to strengthen their balance sheets by raising some €50bn between January and April this year.