EurozoneYesterday, the European Central Bank (ECB) said that of the 130 Eurozone’s banks, 25 failed the 2014 stress test, a landmark event prior to it taking over supervision. Overall, the results suggest leftover problems under capitalization in the Eurozone focus on the region’s small to medium-sized financial institutions.

However, this has raised some questions in the United States where regulators have concern about the strength of the balance sheet for some of the larger banks like Deutsche Bank AG.

Of the 25 failed banks, nine are in Italy and the rest are located in Slovenia, Cyprus, and Greece. Major banks in Germany and France emerged untouched while there were no reported failures for institutions in Spain.

The stress test provided officials an overview to help determine if banks had enough capital to get through a two-year recession, as well as new challenges specific to financial markets. As its benchmark for the test, year-end 2013 balance sheets were used. The pass threshold was a 5.5% ratio of top-quality capital to risk-adjusted assets.

In a statement from the ECB, of the 25 failed banks, 16 raised adequate capital since year-end 2013, thereby allowing them to pass the test. The nine banks in Italy will now have two weeks to develop a plan that will correct the problem and then have nine months to fully implement it.

More than 80% of banking assets in the Eurozone are included in the test. The goal is to ensure that ECB will not take on significant risks in November, at which time it will take over supervision responsibility of the banks involved but also make sure markets gain more faith in ECB’s credibility as a supervisor.

In comparison to the United States, the Eurozone was much slower to recognize the magnitude of problems relating to its banking system following the 2008 crash, primarily because at that time, many countries could not afford the cost of rescue. Based on this, the first attempts by Europe to rebuild confidence using stress tests failed horribly since politicians would acknowledge that problems existed at critical banks like Bankia SA, Franco-Belgian, and Dexia SA.

To some, the number of banks that failed the stress test, as well as the amount of capital shortfall seemed surprisingly small. It also appears the results of the test do not focus on criticizing systemically important banks since those banks were able to raise a considerable amount of capital following the test announcement in July 2013.

In looking at just the 30 largest banks, enough capital was raised in time, coupled with various measures being taken such as selling assets to improve the strength of the balance sheet. However, the ECB added the value of the assets for those 130 banks was overstated about 2% of the total.

According to Mario Draghi, ECB President, one reason that lending was shockingly weak in the Eurozone for 2014 was the unwillingness of banks to take on new risks while the stress tests loomed overhead.

Vitor Constancio, ECB Vice President commented that a thorough review of positions for the largest banks in the Eurozone will help boost public confidence pertaining to the banking sector and that by identifying risks and problems, balance sheets can be repaired and become more resilient and strong.

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