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Do European banks need tougher stress tests?

Eight European banks flunked a financial health check meant to reassure investors. But critics argue for tougher tests to weigh the impact of a sovereign default.

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The European Banking Authority (EBA) says 8 out of 90 banks in the European Union failed a stress test, designed to check the robustness of financial institutions in times of crisis. Another 16 banks were in the danger zone, the London-based EBA added. Five of the failed banks are in Spain, two are in Austria, and one is in Greece.

The stress test and the EBA itself were created after the global financial crisis of 2008, triggered by the collapse of investment bank Lehman Brothers. In the test the EBA plays through a number of scenarios, assuming a drop in economic growth and falling share prices, a devaluation of the dollar, and a shrinking real estate market. Banks that take part in the test are expected to hold at least 5 percent equity capital as a financial cushion.

The tests are meant to provide information for investors on the state of health of Europe’s top lenders. But the US-based ratings agency Standard & Poor's issued a statement, arguing that tougher testing was needed.

"We consider that the European Banking Authority has pitched its stress scenarios at a level that attempts to be sufficiently tough to reassure markets, but not so stringent as to suggest material capital shortfalls," the agency said. "We consider that a moderately harsher scenario would add greater value in terms of assessing the resilience of the European banking sector."

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