Fears bank stress tests too weak

European regulators have found seven banks need to raise a combined €3.5 billion ($6.2 billion) of capital, leading analysts to think the stress tests may not have been strict enough.

"The amount of capital needed is much lower than the market expected," said Mike Lenhoff, chief strategist at Brewin Dolphin Securities in London, which oversees US$33 billion.

"It seems quite trivial considering the concerns about losses from the sovereign crisis."

Germany's Hypo Real Estate Holding, Agricultural Bank of Greece and five Spanish savings banks did not have adequate reserves to maintain a Tier 1 capital ratio of at least 6 per cent in the event of a recession and sovereign-debt crisis, lenders and regulators said.

The banks that failed the stress tests were in "close contact" with national authorities over how they would raise capital, said the Committee of European Banking Supervisors (CEBS), which ran the assessments of 91 lenders.

European Governments are using the tests to reassure investors about the health of financial institutions after the debt crisis pummelled the bonds of Greece, Spain and Portugal.

Rising budget deficits in those countries raised concern that they would not be able to pay their debts.

'This is not reassuring at all," said Komal Sri-Kumar, who helps manage US$118 billion as chief global strategist at TCW Group in Los Angeles.

"These tests were set in such a way that most of them would pass. That doesn't say to me that the banking system is stable."

Before the results were published at the weekend, analysts at Goldman Sachs Group estimated lenders would need to raise €38 billion and Barclays Capital said they would require as much as €85 billion.

Tests carried out in the United States last year found that 10 lenders, including Bank of America and Citigroup, needed US$74.6 billion.

"I don't think the market is so stupid as to think that they were so wrong,"said Jason Brady, a managing director at Thornburg Investment Management in New Mexico, which oversees about US$57 billion. "The right explanation here is that the testing was not very rigorous."

European banks had raised €220 billion in the past 18 months, Credit Suisse Group analysts said.

With that amount raised, it was likely most European banks would pass the tests, the analysts said.

Analysts and investors said the European tests might not have been strict enough because they ignored the majority of banks' holdings of sovereign debt. The evaluations took into account potential losses only on government bonds the banks trade, rather than those they are holding until maturity, CEBS said.

Lenders hold about 90 per cent of their Greek government bonds in their banking book and 10 per cent in their trading book, a survey by Morgan Stanley analysts showed.

They have to write down the value of bonds in their banking book only if there is serious doubt about a state's ability to repay in full or make interest payments.

The European Central Bank said banks that failed the tests should seek to raise capital from investors before turning to national Governments. Spain and Greece both moved to support their lenders requiring capital.

Agricultural Bank of Greece, the only one of the nation's lendersto flunk, said it was preparing arights offering after posting ashortfall of €242.6 million. The Government, which owns 77 per cent of the bank, said that it wouldtake part in the share sale.

Hypo Real Estate, the German commercial-property lender rescued by the Government during the financial crisis, had a capital shortfall of about €1.25 billion.

Spanish savings banks CajaSur; a group led by Caixa Catalunya; a group led by Caixa Sabadell; Caja Duero-Caja Espana; and Banca Civica all posted a combined capital shortfall of €2 billion.

Bank of Spain Governor Miguel Angel Fernandez Ordonez said the central bank would set a deadline for the banks to raise capital privately before turning to public funds.

- BLOOMBERG