European bank tests put focus on capital hikes

European finance ministers will shift their focus next week onto a possible need for banks to raise more capital and on who will cover any shortfalls exposed by stress tests -- a sum which Credit Suisse estimated could reach 90 billion euros ($114 billion).

Euro zone finance ministers, meeting in Brussels on Monday and Tuesday next week, are expected to discuss the policy response countries will take if the tests show problems, an EU source said.

Underscoring the sensitivity of the issue, European Central Bank President Jean-Claude Trichet on Friday reiterated the crisis was not over and banks should remain open to accepting help.

German landesbanks could have to raise up to 37 billion euros as a result of the stress tests that are being conducted by industry regulators and which measure the impact of a possible further economic downturn on banks' balance sheets, Credit Suisse suggested in a research note.

Spanish savings banks, which so far have tapped into 11.2 billion euros of the country's restructuring fund, would also need another 12 billion euros in a scenario where the economy weakened sharply and discounts were required on sovereign debt, the note said.

But Spain's economy minister Elena Salgado said on Friday that the test would show that banks in the country, where fears have receded over the viability of its economy, were solvent.

Credit Suisse suggested, however, that the real issue is not the banks' performance, but the ability of nations to potentially provide more support for their banks. Some have suggested European governments may have to tap mechanisms in the euro bailout plan to fund any bank recapitalizations.

"The important point being tested is the ability and willingness of the official sector to provide capital to firms which fail the stress test - it is this, not the capital position of European banks, which is the subject of severe market uncertainty, in our opinion," the note said.

John Lipsky, the first deputy managing director of the International Monetary Fund, said it appeared Europe was following the necessary steps to make the process work.

"The important thing is it looks like there is a clear commitment to the steps that would be necessary to provide a successful operation," Lipsky told Reuters Insider television on the sidelines of a conference in Frankfurt.

Criticism of Methods

The Committee of European Banking Supervisors said on Wednesday it would test 91 banks across Europe to see how they would hold up if the economy deteriorated and the banks had to take haircuts on some sovereign debt holdings.

Some 65 percent of the European banking sector will come under the umbrella of the testing, the results of which are due to be released on July 23. "Passing" would suggest a bank could withstand the stress scenario, while "failing" would imply it needs more capital to preserve core ratios in the scenario.

While CEBS has not published its full methodology what details it has released have come in for criticism from analysts and finance experts, who say the committee is not testing anything like a worst-case scenario.

But the European Banking Federation warned on Friday the haircuts on sovereign debt in the testing could be deeper than has been suggested.

"If we understand well, they apply quite important haircuts on sovereign bonds, 17 percent on average. That means going from 5 percent to 30 percent, depending on the country," the EBF's secretary-general, Guido Ravoet, told Reuters.

There is already ample speculation that some banks might not pass the test. Equinet analysts said Friday that Postbank (DPBGn.DE) was at the highest risk of the German banks, while Evolution Securities said Thursday it saw severe risk for National Bank of Greece. (NBGr.AT)

But sources close to Postbank said on Friday it was on track to pass the tests.

CEBS has hoped to take a page from the U.S. stress tests conducted last year, which were designed to draw a line underneath the sector's troubles and sort out who needed what to cover potential exposures to bad debts.

Those tests also boosted shares across the U.S. sector, and European analysts hope for the same.

Since hitting a nearly four-week low on Monday, the Stoxx 600 European banking sector share index .SX7P has risen just over 10 percent, while the FTSEurofirst 300 index .FTEU3 is up about 5 percent in the same period. On Friday the banking sector index was 0.2 percent firmer.

($1=.7885 euros)

[Source: By Ben Berkowitz, Reuters, Amsterdam, 09Jul10]

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