Europe's banking regulator reveals eight banks fail stress tests

European Banking Authority, the EU's London-based regulator for the financial sector, carried out assessments on 90 banks. Photograph Pedro Armestre/AFP/Getty Images

Europe's new banking regulator warned that an escalation in the eurozone crisis could pose "significant" challenges even as it announced only eight banks out of 90 had failed an annual check of their financial strength.

A further 16 banks were also deemed to be in a potential danger zone as they only just passed the tests, which looked at the impact on banks' capital cushions of a deterioration in the economy and house prices. However, the tests failed to consider what may happen to banks if a major European country – such as Greece – defaulted on its debt, promoting many analysts to argue the hurdles were set too low.

As the results of the tests were announced by the European Banking Authority (EBA), European Union president Herman Van Rompuy called the leaders of the 17 members of the eurozone to a summit next Thursday to thrash out the much anticipated second bailout for Greece.

Anxiety about Greece continues to put the eurozone under severe stress and Andrea Enria, chairman of the EBA, described current market conditions as "under severe strain" as he said: "Further deterioration in the sovereign debt crisis might raise serious challenges."

All Britain's banks – bailed out Royal Bank of Scotland and Lloyds Banking Group as well as Barclays and HSBC – passed though they suffered a 25% reduction in their capital cushion during the adverse scenarios imposed upon them by the Europe's banking authorities. Only Greek banks suffered a larger fall – of 40% – demonstrating the wide range of exposures of Britain's banks.

Of the four UK banks tested, Royal Bank of Scotland had the lowest capital cushion after the stress tests of 6.3% while Lloyds had a ratio of 7.7%, Barclays 7.3% and HSBC was the highest at 8.5%.

The market had expected a larger number of banks to fail than last year when seven banks failed and needed to raise €3.5bn of capital in tests that were quickly discredited after Ireland's banks – all given a clean bill of health – needed to be bailed out four months later. The capital shortfall of the banks that failed in the most recent tests, which looked at bank's capital positions at the end of 2010, was just €2.5bn.

Jason Karaian, economist with The Economist Intelligence Unit, said: "Under a more realistic test, the actual capital shortfall is likely to be at least ten times the official estimate of €2.5bn. And given that the markets are rewarding safety and security over growth and risk, banks will be under pressure to build their capital buffers, regardless of how they fared in the stress test."

Of the eight banks that failed five were in Spain: Caja de Ahorros del Mediterraneo, Catalunya Caixa, Banco Pastor, Unnim, Caja 3; two in Greece: Eurobank and ATE Bank; and one in Austria: Volksbanken. Another bank, Helaba of Germany, also failed but refused to participate after it disagreed with the conclusion by the EBA that it had failed the test.

Enria defended the decision not to include a default scenario on any of the bonds held by banks and he ruled out any emergency stress tests on banks should this occur before next year when the tests are due to run again. Market experts will spend the weekend scrutinising the unprecedented amount of information published by each bank about their exposure to troubled European countries.

The number of failures would have been as high as 20 without capital raisings totalling €50bn in the first four months on this year. Other banks passed only because they already had government support.

The banks which have failed will now be required to raise more capital – and pressure is likely to be exerted on those 16 banks whose core tier one capital ratio was between 5% and 6%.

While none of the four banks in Portugal – which is being bailed out by the EU and International Monetary Fund – which were tested failed, two have pledged to strengthen their balance sheets in the next three months. They are Banco Comercial Portugues, the country's largest listed bank, and Espirito Santo.

Spain, which suffered more failures than any other of the 27 countries involved in the tests, defended the performance of its banks. Central bank governor Miguel Angel Fernandez Ordonez (pictured below), said: "Spain is taking part with all its banks, and that creates greater confidence. The results are as expected."

Spain's savings banks, or cajas, lent heavily to developers so that they could build homes and buy land before the housing bubble burst in 2007. Now they are the owners of a large, if unknown, number of the estimated 700,000 unsold new homes in Spain – mostly taken in lieu of developers' debts – and of land that has plummeted in value.

Ahead of the results, speculators had been focusing on Italy: pushing the country's borrowing rates to record levels but none of the five banks tested failed. The results were announced minutes after another positive development for hard-pressed Italy: the lower house of parliament, the Chamber of Deputies, gave final approval to an emergency austerity package rushed through the legislature in under a week.

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