On Friday, the London-based Committee of European Banking Supervisors is to publish the results of tests done by national regulators on 91 European Union institutions that represent 65 percent of the EU banking sector.
In addition to the 16-nation eurozone, banks in Britain, Denmark, Hungary, Poland and Sweden have been checked to see if they are sufficiently capitalised to withstand shocks such as those that caused the collapse of US investment bank Lehman Brothers in September 2008.
The tests cover at least half of each country’s banking sector as measured by assets held by leading banks.
A key yardstick is a bank’s Tier 1 ratio, which measures core capital against total assets, such as outstanding loans.
Banks must maintain a minimum ratio of 6.0 percent while a surplus reassures investors the bank is not likely to find itself suddenly strapped for cash.
Another important criterion is a bank’s vulnerability to potentially heavy losses on sovereign bonds issued by certain eurozone member states.
Ministers in several European countries, as well as the head of the European Central Bank, Jean-Claude Trichet, have said they expect that most institutions will be deemed to be in sound financial shape.
Ratings agency Fitch has said that banks found to be in difficulty will likely be provided with fresh capital by governments.
But analysts do foresee that some European banks will fail the tests.
The Australian bank Macquarie on Wednesday listed those banks it felt might not be able to resist severe shocks in the future, among them Germany’s Postbank, Banco Popolare of Italy, BCP of Portugal and Spain’s Sabadell.
Four Greek banks were also on Macquarie’s list – the National Bank of Greece, EFG Eurobank, Alpha Bank and Piraeus Bank.
In Germany, attention has focused on troubled state-owned banks, especially Hypo Real Estate, a distressed property lender and municipal-funding specialist that was nationalised last year.
HRE has reportedly failed the stress test, which would surprise very few people since the bank itself has said it needs €2 billion in fresh funds.
HRE has already received €7.85 billion from the German financial sector stabilisation fund SoFFin, along with €103.5 billion in loan guarantees.
At the end of March, the lender had around €39 billion in exposure to sovereign debt from weaker eurozone countries like Greece, Ireland, Italy, Portugal and Spain whose bonds have all been under pressure.
Other German banks thought to be at risk include regional banks like LBBW, Bayern LB, WestLB and HSH Nordbank.
A 2005 EU decision that abolished favourable conditions for such banks sent many seeking lucrative investment opportunities and they ploughed funds into risky US mortgages on which borrowers subsequently defaulted in large numbers to spark the US sub-prime crisis.
ING strategist Jeroen van den Broek said that in general, “the greatest fear is that the test shows too little diversification between the good, the bad and the ugly, and is seen by the market as being too optimistic.
“The outcome simply must be realistic; a true classification of the European banking system with necessary capital injections lined up will, in the long term, be beneficial to banking confidence.”
In Germany, SoFFin has €255 billion in loan guarantees and more than €50 billion in capital standing by to help out banks that come up short.
Bank of America Merrill Lynch analysts said: “The European stress tests will ultimately be judged a success … if they help to promote the recapitalisation of the banking sector but they too are just one step in a longer healing process.”