Financial markets have reacted positively to the results of stress tests on 91 of the EU’s biggest banks, increasing government hopes that the exercise will restore investors’ faith in Europe’s financial sector.

The value of the euro rose after the publication of the results to reach $1.2916, compared to $1.2892 in late trading on Thursday. The euro had, earlier in the day, fallen to $1.2794 because of concerns that the stress-test exercise would not be sufficiently tough.

Stock markets also made gains yesterday because of the stress tests, with the two major US indexes, the Dow Jones Industrial Average and the S&P 500, both closing higher than on Thursday. The Dow Jones gained 0.99%, while the S&P 500 gained 0.82%.

Analysts said, however, that while the initial market reaction was positive, the real test will come when markets open on Monday, as by this stage investors will have had more time to study the results, as well as accompanying data on banks’ holdings of EU government bonds.
Monday will also be the first chance that the European and Asian markets have to react to the results, as these markets were already closed when the information was published yesterday at 18.00 Central European Time (CET) time.

The stress-test exercise was carried out by the Committee of European Banking Supervisors (CEBS), which is made up of national bank regulators. It assessed whether 91 banks could withstand a sudden financial shock that caused a double dip recession and a significant drop in the value of their government-debt holdings. Governments agreed in June to make the results of the tests public to allay market concerns that European banks were hiding the true extent of their losses from the financial crisis.

Only seven banks were found not to have sufficient capital to withstand the financial shock. They were Germany’s Hypo Real Estate (HRE), five Spanish savings banks (Diada, Espiga, Banca Civica, Unnim and Cajasur) and the Agricultural Bank of Greece (ATEbank). The banks had a combined capital shortfall of €3.5 billion.

Central banks and regulators have been quick to reassure financial markets that action will be taken to raise these banks’ capital to the necessary level. They said that, as a last resort, this could be done through state aid.

Miguel Ángel Fernández Ordóñez, governor of the Bank of Spain, said that the central bank would set a deadline, possibly for the end of this year, for the five Spanish savings banks that failed the test to raise the extra capital they need through private means. He said that state support could be provided if any of the banks fail to meet this deadline. Banca Civica has announced plans to raise €450 million through bond sales.

George Papaconstantinou, Greece’s finance minister, said that ATEbank would be required to present a plan to bolster its capital by the end of the year. The bank has announced that it will try to raise capital by issuing shares.

Germany’s central bank and the German Federal Financial Supervisory Authority (BaFin), said that HRE, which was nationalised during the financial crisis, was undergoing a “far-reaching” restructuring process that would ensure its future stability. It said that this process would include the transfer of €210bn of impaired assets to a ‘bad bank’, a step that would bring it into line with the stress-test requirements.

In Italy, where several banks passed the test by narrow margins, the government said that it would reactivate a dormant scheme that allows banks to issue government-backed bonds.

The European Commission would need to approve state-aid provided by governments to banks in the wake of the publication of the results, but has indicated that it is prepared to do this very quickly.

Governments have welcomed the results as proof of the soundness of the EU’s financial sector.

Wolfgang Schäuble, Germany’s finance minister, said that the results were an “important step” towards reinforcing market confidence. “Transparency regarding the resilience of European banks has clearly increased,” he said.

Christine Lagarde, France’s finance minister, said that the results proved “the solidity of the whole French banking sector”. She said that efforts by the state to support the banks during the financial crisis had “borne fruit”.