Twenty-five eurozone banks flunked financial-health exams designed to measure their ability to withstand another economic crisis, falling short of minimum levels of capital by a total of €24.62 billion ($31.17 billion), the European Central Bank said Sunday.
The number of failures, and the depth of the cumulative capital shortfall, was slightly larger than what analysts and investors expected European regulators to identify during their “stress tests” of 150 of the continent’s leading banks.
The ECB said most banks that failed have taken steps this year to substantially boost their capital buffers. Twelve of the 25 banks that were tripped up in the stress tests have already covered their capital shortfalls, raising a collective €15 billion this year. That leaves an extra €9.47 billion that banks still need to come up with.
“This unprecedented in-depth review of the largest banks’ positions will boost public confidence in the banking sector,” said ECB Vice President Vítor Constâncio. “By identifying problems and risks, it will help repair balance sheets and make the banks more resilient and robust. This should facilitate more lending in Europe, which will help economic growth.”
No major bank failed the tests. Failures were concentrated in Italy, where nine lenders didn’t pass, and Greek and Cypriot banks, with three apiece.
Among the largest banks to fail was Banca Monte dei Paschi di Siena SpA, Italy’s third-largest lender, which faces an outstanding capital hole of about €2.1 billion, despite already having raised €2.14 billion between Jan. 1 and Sept. 30 this year. The failure prompted Monte dei Paschi to hire investment bankers at Citigroup Inc. and UBS AG to advice on strategic options, including a possible merger, according to people familiar with the matter.
The other Italian banks that need to raise capital are Banca Carige SpA, Banca Popolare di Milano SCARL and Banca Popolare di Vicenza ScpA need to raise new capital, taking the total shortfall for lenders in the eurozone’s third-largest economy to €3.3 billion. The other Italian banks that failed have already covered their capital shortfall, the ECB said.
“Bank of Italy has a lot of explaining to do,” said Nicolas Veron, a senior fellow at Brussels-based think tank Bruegel. “Rumors that it was not as cooperative as others during the AQR [asset quality review] gain credibility now that results are public.”
Italy’s central bank, the Bank of Italy, argued that the total capital shortfall is smaller than it seems. Taking into account capital-generating measures such as asset sales and accounting adjustments, the banks’ outstanding capital shortfall shrinks to €2.9 billion, it said. Banca Carige, for example, is selling two insurance businesses to help close its €814 million gap and said Sunday that it plans a €500 million capital increase.
“The results confirm the solidity of the Italian banking system, despite repeated shocks suffered by the Italian economy in the last six years,” the Bank of Italy said in a statement.
Elsewhere, Portugal’s Banco Comercial Português still needs to raise €1.15 billion, while the ECB said that although Greece’s Eurobank Ergasias SA and National Bank of Greece SA were shown in the tests to still be lacking a combined €2.66 billion in capital, they should be covered thanks to restructuring plans that weren’t taken into account in the exercise.
Banks that received failing marks, and which haven’t already filled their capital holes, now have two weeks to explain to regulators how they plan to overcome the deficits. They will then have six to nine months to implementing those plans, which may be harder for some than for others.
As part of the exercise, the ECB also reviewed the quality of bank assets, such as mortgages, corporate loans and other investments, to determine whether they were accurately valued. That process resulted in banks being forced to reduce the value of their assets by a total of €47.5 billion, the ECB said. The central bank also identified a total of €135.9 billion of troubled assets, known as nonperforming exposures, sitting on the balance sheets of the eurozone banks.
The grueling, yearlong testing process represents the latest attempt by European officials to dispel years of anxiety about the health of the continent’s banking industry, which was shaken by the global financial crisis and then badly destabilized by Europe’s sovereign-debt crisis.
Previous versions of stress tests, in 2010 and 2011, were widely criticized because of computational problems and after banks that received passing marks required taxpayer bailouts. Partly as a result, Europe’s financial crisis dragged on far longer than that of the U.S., which swiftly recapitalized its ailing banks. Just this summer, the sudden collapse of Portugal’s second-largest lender, Banco Espírito Santo SA, rattled European markets.
European Union officials and economists hope the publication of the test results, as well as the release of more than 1 million financial data points about the banks, will improve confidence in the industry. That, in turn, should make it easier for banks to issue affordable loans to household and business customers, spurring much-needed economic growth.
Analysts and investors, meanwhile, expect the tests to boost many banks’ stock prices and potentially unleash a wave of consolidation as concerns ease about skeletons lurking in banks’ closets.
“The banks with capital shortfalls could face tough times ahead if the ECB sticks firmly to the timetable they’ve set out, especially those that have already raised substantial capital compared to their size,” said Neil Williamson, co-head of credit research at Aberdeen Asset Management .
The number of failures partly reflects the billions of euros of capital that European banks have raised in the past few years, as well as the huge volumes of assets they have shed.
The ECB said that since the stress tests were announced in July last year the 30 biggest eurozone banks alone had raised €60 billion and strengthened their balance sheets by more than €200 billion.
To pass the tests, banks had to maintain a capital buffer of at least 8% of risk-weighted assets under a scenario in which the European economy develops as expected until 2016. They would have to keep their capital buffer at 5.5% under a simulated three-year crisis, in which the EU’s economy shrinks 7% below current forecasts and unemployment soars to a record 13%.
The ECB said that under that worst-case economic scenario, banks’ capital cushions were depleted by €263 billion, reducing their median capital ratio by four percentage points to 8.3%.
For the ECB, Sunday’s results are the final milestone before it takes over supervision of major eurozone banks on Nov. 4. Turning the ECB into the currency union’s bank watchdog is a key step to setting up a so-called eurozone banking union. The hope is that moving control over important banks out of national hands will prevent the kind of banking crises that rocked Ireland, Spain and Cyprus in recent years.
To avoid a repeat of these problems, the EU has passed a flurry of new banking laws in recent years, including limits on government bailouts. Under the new rules, any bank that fails to cover capital shortfalls privately, either by selling new shares or getting rid of assets, will have to impose losses on shareholders and certain creditors before any public money can be injected.