Investors braced for results of EU’s ‘stress tests’ on banks

The European Central Bank, the EU’s main financial regulator, is set to reveal the results of the latest round of 'stress tests' of 130 banks’ balance sheets.

The headquarters of the European Central Bank in Frankfurt. The ECB is set to move to its new home by the end of 2014. Ralph Orlowski / Reuters

Global investors are bracing themselves for news of the financial health of European Union banks as the euro zone continues to weigh on the world economy.

The European Central Bank, the EU’s main financial regulator, will reveal on Sunday the results of the latest round of “stress tests” of 130 banks’ balance sheets, in what has been seen as a crucial test of the continent’s ability to climb out of the low-growth environment it has suffered since the financial crisis of 2009.

The results could have a significant effect on the ability of European banks to help kick-start economic expansion by funding businesses of all sizes. Many EU banks have been slow to extend credit for business in the wake of the euro-zone sovereign debt crisis, in which banks and countries defaulted on international loans.

Banks that fail the stress tests will have to quickly raise new capital from international markets, which could drain funds away from growth areas.

Bloomberg reported that about 25 banks would fail the tests, according to drafts of the ECB’s results, which examine banks’ financial status at the end of last year. Most of those will have raised new capital in the course of this year, but the agency said that about 10 – in Spain, Italy, Greece and Ireland – would have to raise new capital quickly.

The ECB has set minimum standards of capital ratios for the banks under its regulation. To pass, banks have to be able to show a minimum Tier 1 capital ratio – the proportion of its hard-core equity to risk-weighted assets – of 8 per cent, to withstand unexpected shocks such as the credit crunch and euro-zone crisis.

Typically banks in the GCC region have much higher capital ratios, of about 15 per cent or upwards. For example, National Bank of Abu Dhabi has a Tier 1 ratio of 16.3 per cent.

"The tests will show one thing: that if we are in exactly the same position as in 2008, the banks will have sufficient core capital. But will the next crisis be the same as 2008? Of course not," Jean Maigrot, the European fund manager at the asset manager NewSmith, told the Financial Times.

The ECB president, Mario Draghi, has said that there needs to be failures in the stress tests to prove the system’s credibility.

In previous tests, banks that passed the ECB’s criteria subsequently developed problems and had to urgently raise new capital.

“It’s too early to say the exercise is credible. The key will be to see how much stress the strong banks will take, and how many of them will pass by a narrow margin,” said Alberto Gallo, the head of European macro-credit research at Royal Bank of Scotland.

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