Eight banks, including two Greek banks, five Spanish and one Austrian bank have failed the European Banking Authority's (EBA) stress tests, the agency said on Friday.
All of the Dutch, British, French, Italian, German and Portuguese banks passed the tests, however several institutions in the latter two countries, as well as several Spanish banks passed, only did so by a small margin, the EBA said. All 10 participating Nordic banks passed.
Two German banks -Nordbank and NordLB - one Slovenian bank, two Greek banks, two Portuguese banks and one Cypriot bank came close to failure, the EBA said. Overall, 16 banks had tier one capital of between 5 and 6 percent, according to the EBA.
The Bank of Italy said that all five of the country's banks passed by a large margin. The three Irish banks taking part also passed.
Volksbank, the Austrian bank which failed the stress tests, issued a statement immediately after the release saying that it would take the result seriously, but criticizing the EBA for failing to take into account measures it had been taking to raise capital, including the sale of international assets to Sberbank.
"The EBA stress test did not take these measures into account in its main result. In this respect, the timing of the stress test was unfavorable for us," CEO Gerald Wenzel said in a statement.
20 banks were below the 5 percent tier one capital mark at the end of 2010, but banks have raised an additional 50 billion euros ($70 billion) in the first four months of 2011.
European markets posted their biggest weekly loss in four months as investors waited for the results of the test. The banking index fell by 0.9 percent on Friday, compounding a 25 percent slide since February. Gilts and bunds ended higher as investors sought safe havens.
Analysts had expected a number of Greek lenders, including EFG Eurobank, Piraeus and ATE Bank, to fail. All three are heavily exposed to their country's sovereign debt. ATE Bank and EFG failed, but Piraeus passed. ATE's capital shortfall was 713 million euros.
Germany's Helaba ruled itself out of the stress test on Thursday after a dispute over whether it could count its hybrid capital. Germany's largest lenders, Deutsche Bank and Commerzbank , passed comfortably.
German finance minister Wolfgang Schauble said in a statement that the results were encouraging.
"It is a positive signal that the European banking sector has demonstrated its stability under these circumstances," he said. "The current situation in the financial markets shows clearly how important confidence in the resilience of European banks is."
Spanish banks Pastor and CatalunyaCaixa had said that they would fail - and did - but that they would have passed if they were allowed to include so-called "generic provisions" – anticipated losses throughout their loan cycles – as core capital. Last year's stress tests allowed this, but the stricter 2011 rules do not. CatalunyaCaixa's capital shortfall was 75 million euros, the EBA said.
Given the amount of money held in generic provisions in the Spanish cajas, analysts expected a number of others to fail. Three - UNNIM, CAM and Grup Caja 3 - did, and seven only barely passed, according to the EBA.
The Spanish central bank said immediately after the release of the test results that the country's banks would not need to be recapitalized because of their additional provisions.
"Whether or not the markets will fully agree with them is an open question," Jason Karaian, an economist at the Economist Intelligence Unit told CNBC.com.
Savings banks Bankia and Banca Civica are due to list next week, and the poor performance of the Spanish banking sector could weigh on their initial public offerings.
"I think Spain has shown an admirable willingness to expose its banks to these tests, and I think that will probably pay off in the long term, but I think in the short term it's a recipe for a lot of volatility and a lot of instability. That's not exactly welcome when somebody like Bankia is trying to list," Karaian said.
“It’s pretty much what we expected but it does not include the issue of sovereign default, and it’s still below the level of Basel anyway. There are no particular surprises here," Justin Urquhart Stewart, co-founder and director of Severn Investment, told CNBC.com.
"The two things that I would like to have seen are what access to funding do the banks that failed the stressed tests have, so how could they get funding and how much could the banks cope with a sovereign default. So the stress tests give some comfort but we need more than that," he said.
"I see this as preparation for a polite default. Let’s now have the provision where we can see which banks can live with a sovereign default and which can’t so we know who need to take a hair cut and who doesn’t."
Another analyst, who wished to remain anonymous, told CNBC.com: “I would say that the stress tests don’t tell us anything new particularly but people will look beyond the immediate answers and look at the banks that passed but not by much… Sovereign bond holdings would also be easier to determine on the basis that European banks will now report their bond holders at the same time so people will be able to work out their own implications in terms of haircuts from that as well,” the analyst added.
The market's expectations for the stress tests were low, with many investors and analysts saying that unless they proved to be very strict that they would fail to boost confidence in the European policy response to the crisis, and could cause the sovereign crisis to spill over into a banking one.
"This process might just leave us all still wondering about our counterparty, and really that's how financial crises get caused, not actually by weak balance sheets, but by people worrying about the state of their counterparty, of their competitors' balance sheets. The worry is as pervasive, if not more so, than the reality," John Ventre, portfolio manager at Skandia Investment Management, told CNBC.com ahead of the results.
Regardless, the results of the stress test alone are not enough to reassure or panic markets, analysts said.
"If it helps us to get us slightly forward towards some kind of solution then maybe it's part of the endgame to achieve that," Alan Wilde, head of fixed income and currency at Barings in London, told CNBC.com.
Identifying the weaker banking players is a start, but doing something about that weakness is the critical issue, Wilde said. European finance ministers have floated the idea of recapitalizing failing banks using state funds, but that creates its own problems.
"The backstop seems to be that governments will make capital available, but where does it end up? It ends up with indebtedness at state level, and more pressure points at a sovereign level, which presumably will not curry favor with the rating agencies," he added. "It migrates alternately from being a banking sector crisis to being a sovereign crisis and back again. I think we're sort of torn between one and the other."
With the results now out, and a whole raft of new data - including banks' exposures to sovereign debt - to pore over this weekend, Monday morning's session could be revealing as to the market's longer term view on whether the euro zone crisis can be resolved, according to analysts.
"I think now, finally, we have the tools with which to draw our own conclusions of how that sovereign-banking feedback loop will resolve. There are some fairly granular disclosures, and you can make up your own mind about who affects whom," Karaian said.