On Sunday, theEuropean Central Bank announced the results of itshealth check of European banks, the findings of which have been eagerly awaited by City analysts and traders alike.
Officially, the health check was known as the Asset Quality Review, or AQR, and saw the bank investigate 130 separate lenders balance sheets with a total value of22trna sizeable sum.
In total, lenders across the Eurozone had overvalued their assets by48bn, leaving a25bn capital hole, although after including the capital raised by banks this year, this capital hole shrank to only9.5bn.
The stress tests were designed to show that banks could withstand a simulated three-year period under stress. During this three-year period, European economic output fell 2.1%, pushing unemployment to 13% and sending house prices down 20% on average. If, after this simulated period, the bank in question had a capital ratio of more than 5.5% then it passed. A bank with a ratio of less than 5.5%failed.
As a result, with only 25 banks of the 130 lenders failing the ECBs tests, many European investors have breathed a sigh ofrelief. It seems as if the European financial system is not on the verge of collapse after all.
Whats more, these results clear the air about the state of European banks balance sheets, removing any concerns that there could be skeletons hiding in the closet.
So, on an individual basis, what did the ECBs tests reveal about RBS, Lloyds and Barclays?
Well, Lloydss results were easily the most shocking of the group. According to the tests, after a simulated three-year period of stress, thebankscommon equity Tier 1 capital ratio fell to 6.2%, only 0.7% above the required minimum of 5.5%. That said, the bank did point out that this stress test was conducted with last years numbers.
RBS performed slightly better than Lloyds. Indeed, despite RBS sluggish recovery since the financial crisis, the ECBs tests revealed that the bank would hold core capital of 6.7% under the adverse scenarios. This result came as a surprise to many analysts, as RBS was expected to be the UKs worst performing bank.That crown has now gone to Lloyds.
And finally, Barclays, which has been faced with a tidal wave of bad news this year, finally got a piece of good news. The ECB revealed that the bank passed its rigorous set of tests with a core capital ratio of 7.1%, 1.6% above the required minimum.
The bottom line
Theres no denying that the results from theECB test are revealing. Lloyds weak performance definitely surprised many analysts, as on the face of it, the bank appears to have staged a solid recovery since the financial crisis.
But the tests are not over just yet. The Bank of England is conducting its own set of stress tests later this year and these tests will use more up-to-date figures, which should give investors a clearer picture on the current state of the industry.
Still, whether or not you share my view on the shares in question, I’m confident that you can benefit from readingthis new report from The Motley Foolthattakes you throughthe seven key steps you need to take to become a stock market millionaire.
“How You Could Retire Seriously Rich“explains how spending just 20 minutes a month could help you create a portfolio that could bring you closer to financial freedomfor life.
Click hereto check out the report–it’s completely free and comeswith nofurther obligation.
Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.