Data Underline Some Banks′ Dependency on ECB

The data make clear the mountain of work that governments and regulators still have to do to restore confidence in their respective banking systems when they release on Friday the results of "stress tests" on 91 of Europe's largest banks.

As reported, the banks must prove that they could sustain a 6% ratio of Tier 1 capital to assets by the end of 2011 even in the event of a fresh recession in the EU, and even if accompanied by an additional bout of volatility in government-bond markets similar to the one seen in May.

That makes the core metric of success or failure comparable to one of the two tests used by the U.S. in its own exercise last year. The EU is hoping that its test will do as much as the U.S. exercise did to dispel fears about the solvency of systemically important banks.

The Committee of European Banking Supervisors said this week that it intends to announce aggregated country results of its tests after the European markets close Friday, with national regulators following hot on its heels with a bank-by-bank breakdown for the 91 institutions. The goal was to allow markets 48 hours of relative calm to assess the data before trading on it.

However, many European banks also are listed in the U.S., exposing them to immediate market scrutiny that their non-U.S.-listed peers would escape.

People familiar with the situation said Wednesday that at least some regulators want to move the release up to before the start of trading in Europe instead.

A final decision on the timing of the announcement is expected Thursday, possibly after a conference call of EU finance ministers.

Switzerland's financial regulator, Finma, is following the EU's lead and will release results of its own tests on UBS AG and Credit Suisse Group AG later this week, according to a person familiar with the situation.

Also Wednesday, top bankers—including the chief executives of Intesa Sanpaolo SpA, Banco Bilbao Vizcaya Argentaria SA, UniCredit SpA and Commerzbank AG—began gathering at the European Central Bank to meet with central bank officials, including President Jean-Claude Trichet.

ECB officials regularly meet with senior bankers, but Wednesday's meeting is of particular interest because of the imminent publication of the test results. No postmeeting news briefing or statement has been announced.

The latest data from central banks underline how negative sentiment toward some European banks has become: Banks in Portugal, Ireland, Greece and—most of all—Spain increased their borrowings from the ECB to record levels in June as more institutions found their access to wholesale money markets barred.

"The reality of the situation is that a growing number of institutions have failed the market's own stress test," said Lena Komileva, head of market economics for the Group of Seven leading industrialized nations at Tullett Prebon.

Global banks have been reluctant to lend to banks in the euro area's weaker periphery all year. Figures published earlier Wednesday by the Bank for International Settlements showed that they reduced lending to Portugal, Ireland, Greece and Spain by $110 billion in the first quarter of the year. Another $81 billion was pulled from Italy.

But alarm bells really started ringing in May, when the ECB had to stem a general rout in southern European bond markets by buying tens of billions of euros of government debt. Wholesale money markets, where banks make up the difference between their loans to customers on the one side and their deposits and capital reserves on the other, have been effectively closed to many southern European and Irish institutions since then.

As such, ECB lending to the banking systems of Portugal, Ireland, Greece and Spain rose by €126 billion ($162.45 billion) in the first half of the year, accounting for almost all of an overall increase of €141 billion. Overall ECB lending volumes have fallen since June, with the repayment of €442 billion in 12-month funds. But by the end of June, these four countries accounted for 42% of the ECB's total lending of €870 billion, up from 33% at the start of the year. By contrast, those countries contribute only 13% of the ECB's capital.

To some degree, that development reflects a fear of country risk, rather than bank-specific risks. The public-debt dynamics of Greece and Portugal in particular have convinced many that a default or restructuring will be necessary before long. But it also reflects the fear that even sovereigns themselves won't be strong enough to save and recapitalize national banking systems that have suffered huge losses as real-estate bubbles exploded in their countries.

The goal of the stress tests was to assess how the 91 banks would stand up against pressure on their loans and assets in an economic downturn.

German Chancellor Angela Merkel said Wednesday the tests are being conducted on "very realistic" terms and should restore confidence in the financial sector. "The stress tests which the European banks are going through right now will need to restore confidence again," she told reporters at a news conference.