European banks fail test, must find $12.5B

FRANKFURT, Germany -- The European Central Bank says 13 of Europe's 130 biggest banks have flunked an in-depth review of their finances and need an extra $12.5 billion to cushion themselves against any future crises.

Although the landmark review identified only a handful of weak banks, ECB officials said Sunday it was tough enough to ensure Europe's banks will be purged of the bad investments that have made some of them hold back on lending.

That means the banks will be ready to lend to businesses when the economy finally picks up, they said.

"The results guarantee that going forward the economic recovery will not be hampered by credit supply restrictions," ECB vice president Vitor Constancio said.

Yet after months of talk about banks that were "zombies" -- walking dead, too weak to lend -- it appeared unlikely that any would be put out of business by the review's results.

The ECB, working with the European Banking Authority, checked the worth of banks' holdings in a so-called asset quality review and subjected the banks to a stress test that simulates how their finances would fare in an economic downturn.

The ECB said 25 banks were found to need 25 billion euros. Of those, 12 had already made up their shortfall during the months in which the ECB was carrying out its review, which was based on bank finances at the end of 2013. They found money by issuing new shares, or by shedding risky investments or loan businesses that reduced the amount of capital needed to backstop those holdings.

The remaining 13 now have two weeks to tell the ECB how they plan to increase their capital buffers and up to nine months to actually carry out the plan.

The hope is that by then, the banking system will be healthy enough to support, not hinder, the economy of the 18-country eurozone. The currency bloc did not grow at all in the second quarter, after four quarters of weak recovery.

As it prepares to become the eurozone's banking regulator, the ECB is under pressure to show its review will be more effective than similar tests carried out by the EU in 2010 and 2011 that gave a pass to banks that later needed bailouts. It had more information because it started with a thorough review of bank holdings, and used tougher financial definitions. For example, it found 136 billion euros in previously unidentified loans and other assets that were shaky and not being paid back on time.

"It's good to have the most obvious dead bodies brought up out of the basement," said Michael Koetter, professor at the Frankfurt School of Finance & Management.

He added it was only a start: "I think it would be naive to believe that one diligence exercise is going to get us to a clean slate and a new era."

Koetter said it remains to be seen how Europe's new banking oversight system will work when it actually has to shut down a bank, a painful process that can provoke political opposition from the bank's home government. A new agency to do that, called the single resolution board, will come fully on line only in 2016.

Nicolas Veron, senior fellow at the Bruegel think tank in Brussels, noted that the review accomplished much by forcing banks to take steps ahead of time. "There has been a lot of proactive behavior by the banks," he said. "They raised a lot of capital because of the stress test, but before the result."

"It's only a start for the process of repair and for the return of trust, but I would argue at this point and with the information that we have, it's an encouraging start."

Italy had most of the banks that needed more capital 4 of the 13. The bank with the biggest shortfall was Italy's Monte dei Paschi di Siena, which was found to need another 2.11 billion euros. Five of the banks Eurobank, National Bank of Greece, Nova Ljubljanska Banka, Nova Kreditna Banka, and Dexia will be able to make up for their capital shortfall simply by sticking to their current restructuring plans.

Most of the other banks that failed were short amounts less than 1 billion euros and in several cases less than 200 million euros.

The bank review and stress tests pave the way for the ECB to take over on Nov. 4 as the eurozone's main supervisor for the bloc's biggest banks, a key step in building stronger financial oversight in the wake Europe's crisis over government debt. The ECB will take over from national supervisors, who were considered to be too easy on their home banks and unwilling to step in to ward off problems.