US Stress Tests Leave Europe's Banks Exposed

The results of the stress tests on 19 of the biggest US banks have left European banks exposed, as they now look vulnerable to recapitalization needs and to claims that not all checks were made to ensure rules were being followed, analysts said on Friday.

"Compared to the US, the European banking system is rapidly being left behind on the bank recapitalization front," UBS analysts said in a research note.

"Unlike the US stress test that set out clear objectives, framework, and deadlines, there is no major policy initiative to recapitalize banks in Europe," they added.

European bank stocks rallied Friday, boosted by relief that no bad surprises arose from the results of the US stress tests, but UBS kept its underweight recommendation, while upgrading their weighting on US banks' stocks to neutral from underweight.

The stress tests' major effect was the removal of uncertainty and this is why US bank stocks surged, Giorgio Questa from Cass Business School told CNBC's "Squawk Box Europe."

Sharon Lorimer

"I would like to see these things done also in Europe, both for the uncertainty and to establish the principle that rules are there to be checked," Questa said.

Analysts at financial services investment bank KBW estimated that 6 major banks would need to raise capital in Europe, needing at least 8 billion euros to bring their tier 1 equity ratio above the minimum required 4 percent.

The banks are German Commerzbank, Danish Danske Bank, Sweden's Swedbank, Ireland's Allied Irish and Bank of Ireland and Italy's Banco Popolare, according to KBW.

Complacency Returning?

Analysts at Credit Suisse said in a note that Europe's banks would need about 84 billion euros of extra capital if they were subjected to a "stressed" case used by U.S. regulators to assess the capital strength of its top banks.

The US banking system will be much better placed to absorb higher credit costs, both from households and from corporations, and resume lending, UBS analysts said.

In February, UBS analysts had estimated that US banks needed an additional $167.4 billion in capital while European banks needed a further $150.1 billion. But, while in US steps were taken to find the resources, little has been done in Europe.

"In our view, the recent rally has allowed complacency to return both among banks as well as at the policy level," according to the UBS research.

Over the past week, European banks reporting first-quarter results revealed that bad debts were surging, sparking worries that deeper losses may follow.

"European banks also face other fundamental risks," UBS analysts wrote, explaining that the impairment cycle in Europe is lagging that of the US by between 9 to 12 months, while Eastern Europe, with its falling economies and depreciating currencies, may be a major headache for the banking system.

Besides, loan to deposit ratios are higher in Europe than in the US, and a coordinated pan-European approach to recapitalizing banks is unlikely, as national interests seem to take priority, they wrote.

UBS's stock recommendations focus on banks that are well capitalized, with strong deposits and are likely to remain independent, as those under state influence could be exposed to "national service" – putting social and political considerations ahead of shareholders' interests.

UBS has a rating of buy on Bank of Nova Scotia, China Merchants Bank, DBS Group Holdings, HSBC , Intesa SanPaolo, Itau and Societe Generale.

Its least preferred stocks include Santander, BBVA, Sabadell, Mizuho, Macquarie, OTP, Millennium, Woori and Taishin.

— Reuters contributed to this story

© 2011 CNBC.com