Banks with substantial peripheral Eurozone bond holdings, and those that only scraped through the European Union's stress test of 90 lenders, started feeling the heat yesterday from investors anxious they should beef up their capital buffers.
The European Banking Authority (EBA) said late on Friday eight banks failed the test with a total capital shortfall of €2.5 billion (Dh12.85 billion).
This amount puny in the broader context of European banking sparked a repeat of last year's accusations that the stress tests were again unrealistic given the Eurozone's sovereign debt crisis.
The major shortcoming of the test was the lack of real stress applied to Eurozone bonds held in long-term banking books. Adding in a realistic stress on peripheral Eurozone bonds would add at least €20 billion to capital needs and maybe more than double that, analysts said.
By 0820 GMT the European bank sector was down 1.5 per cent, hovering just above the two-year low hit last week. Intesa Sanpaolo, Unicredit, Deutsche Bank, Societe Generale and Barclays all fell more than 3 per cent.
Current market prices imply a much more severe loss than the EBA's assumption of a 15 per cent loss on Greek bonds and a 1 to 2 per cent "haircut" on Irish and Portuguese debt.
The EBA data showed banks held €98.2 billion of Greek bonds (67 per cent held by domestic banks), €52.7 billion of Irish sovereign debt (61 per cent held domestically) and €43.2 billion to Portugal (63 per cent at home).
Applying more realistic losses of 40 per cent on Greek bonds and 25 per cent on Portuguese and Irish debt would add over €45 billion to capital needs.
The knock-on effect on funding markets could be even more damaging, leaving attention fixed on how talks progress later this week on finding a solution to the Greek crisis.
"The European banking sector is captive to politics at the moment," said Hank Calenti, credit analyst at Societe Generale.
Eurozone leaders meet on Thursday in a bid to agree a second bailout for Greece and a package to address the broader fiscal woes of the Eurozone that last week moved beyond Greece, Portugal and Ireland to Italy and Spain.
This broader package may include measures whereby banks agree to take a hit in some form on the sovereign debt they hold to give Eurozone countries more breathing space to recover.
The EBA test, though flawed, did provide over 900 pages of data, including 250 on Spanish banks alone.
"The key positive is greater understanding and recognition of sovereign stress," Huw van Steenis, analyst at Morgan Stanley, said in a note.
Banks could need between €40 billion and €64 billion of capital, based on a test overlaying the EBA's adverse scenario with a sovereign stress using implied losses from current market prices and a minimum core Tier 1 capital level of seven per cent, Morgan Stanley estimated.
Banks warned that too much transparency, such as news of BNP Paribas' €24 billion exposure to Italy, may make markets even more jittery.
The banks that failed were small, nearly all untraded and mainly in Spain, where banking problems have long been known.
Sixteen banks scraped through the test and analysts expect them to come under market pressure to bring capital cushions up to scratch well before the EBA's April 2012 deadline.
They include Spain's Bankia which is planning a stock market listing tomorrow Popular, Sabadell and four more Spanish banks, along with Italy's Banco Popolare, Greece's Piraeus and Cyprus's Marfin.
From / Gulf News