Mervyn King: This is European banks’ ‘last chance’

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The upcoming European banking asset quality review will represent the sector's "last chance" to prove its credibility, former Bank of England Governor Mervyn King told CNBC.

The European Central Bank (ECB) plans to publish the results of the review of 128 bank balance sheets in late October and will assess the actions banks have taken to strengthen their capital positions.

"Financial markets will be looking very carefully in the autumn at whether the statements made about the capital positions of different banks are really credible and a lot hangs on this," King told CNBC following his keynote speech at the Diggers and Dealers 2014 conference in Kalgoorlie on Monday.

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"The previous stress tests for banks in Europe didn't really convince markets of their seriousness – and this is a really last chance for Europe to put in place a really credible set of tests on the financial worthiness of all the banks in Europe," he added.

European authorities have conducted regular bank 'stress tests' since 2009, designed to increase the sector's resilience to another economic downturn and restore investor confidence, but the 2014 round has been billed as the toughest.

Sir Mervyn King, Former Governor of Bank of England.
Clive Brunskill | Getty Images

ECB President Mario Draghi earlier this year sounded a warning that some of the banks were likely to fail.

King, who was governor of the BOE from 2003 to 2013, told CNBC it's paramount for banks to take an honest and transparent approach.

"What will be disappointing is if the review comes up with very reassuring answers about the banking system that markets clearly don't believe," he said.

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"This is a time when honesty is absolutely vital. Transparency and honestly; facing up to problems on bank balance sheets; [and] injecting new capital, is the only way forward from now on and it will be a test of Europe to see whether it's willing to do that," he added.

The upcoming asset quality review is particularly poignant given the recent scandal surrounding Portugal's largest lender Banco Espirito Santo, now being bailed out for 4.9 billion euros ($6.58 billion) by the Portuguese government, it was reported on Monday.

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The bank's troubles emerged in May when its parent company Espirito Santo International (ESI), received an audit by the country's central bank which showed "irregularities" in its accounts.

Separately, the ex-governor gave his view of the decreasing importance of central banks in terms of stimulating economic growth.

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"They were vital in the period 2008 and 2010… [but] we have to accept that central banks are no longer the answer," he said.

"The secret to recovery now will depend on other policies: partly on policies to boost productivity and raise future incomes; and partly more flexibility on exchange rates, and these things will be needed to re-balance the world economy," he added.