European Bank Stress Tests Demonstrate Systemic Weakness

There’s good news and bad news about the health of European banks.  Of the 91 financial institutions that recently underwent stress tests, only seven outright failed. Those seven who did not perform well were ordered to raise their capital by €3.5 billion (approximately $4.5 billion).  The number of failures were far less than what was expected, though the results confirmed fears that the stress test was too easy.

The results indicate that 91 banks in 21 European nations would be able to cope with a second recession, even though investor confidence has been shaken by the Greek debt crisis.  “I see nothing stressful about this test.  It’s like sending the banks away for a weekend of R&R,” said Stephen Pope, chief global equity strategist at Cantor Fitzgerald.  “There is little evidence that the tests have been applied consistently and there is a distinct lack of credibility, making it a wasted opportunity,” said Richard Cranfield of the international law firm Allen & Overy.  Even though the modest findings cast doubt on how credible the bank tests were, it may not matter because the European economy is recovering quickly.

Five small regional Spanish lenders who failed the test will require recapitalization that will accomplish a state-funded drive to unite the nation’s network of unlisted savings banks.  They included the Banca Civica, Diada, Espiga, Unnim and Cajasur.  All told, these small banks need €1.8 billion, according to the Bank of Spain.  Several German and Greek banks also were perceived as weak and in need of restructuring, although the state-owned Hypo Real Estate was the only German lender to flunk, as was the Greek owned ATEbank.  Banks that nearly failed with a Tier 1 ratio of less than seven percent under the most stressed scenario included Germany’s Deutsche Postbank, Greece’s Piraeus, Allied Irish Banks, Italy’s Banca and Spain’s Bankinter.  According to Cranfield, “The banks that have scraped through may have more of a challenge on their hands and they may be the ones the market focuses on,” Cranfield concluded.