Stress tests: what the results mean for bank shares

Pass rate set too low

The fact that only 8% failed in Europe compared to a 47% failure rate in a test of US banks is one of the reasons some are worried the European testers failed to do what is needed.

There are two main areas of concern; whether the banks have enough capital to cope with another downturn and whether the tests do enough to bring about new market confidence, lead to looser credit markets and enable banks to refinance at affordable prices.

Real tests still to come

If lenders remain reluctant to lend to some banks because they are not convinced by the results of the tests it is possible that all banks may have to pay more to borrow.

Mark O’Sullivan, director of dealing at Currencies Direct, said: ‘It seems the tests may have raised more questions than they have answered and in the coming weeks it will be the interbank lending markets that will have the real answer as to whether real confidence has returned to the European banks.’

Simon Samuels, analyst at Barclays Capital, believes too many banks are fighting over a limited supply of funding.

‘With or without a stress test, Europe’s banks still have €1.5 trillion of debt maturing by 2012, as well as the need to repay over €500 billion to central banks,’ he said.

He thinks higher overall funding costs – and the differential in costs among banks – will remain in the months ahead.

What does that mean for shares?

Most agree that the massive jump in bank shares that followed the US and UK tests will not be repeated in Europe over the coming weeks.

There remain regulatory risks with a number of plans to rein in the banks still being considered in the UK and across the globe.

A key catalyst is the final decision on how much capital banks will be required to hold. Recent talk has suggested that the Bank of International Settlements has been listening to the banks and rules will be watered down. But there will still be some uncertainty until a final decision is made.

Alan Webborn, analyst at Societe Generale, said: ‘We favoured strong banks before the tests and our view has not changed on publication of the results.' His key recommendations are Barclays and Lloyds.

Others agree that the relative strength of the UK banks and the upcoming earnings reporting season means UK bank shares could outperform over the weeks ahead. All bar RBS are on many brokers' 'buy' lists.