European banks brace for stress-test report cards

Some struggled with U.S. stress tests. Now, they have to play at home.

Back-to-back stress tests for European banks mean that a difficult June could turn into a painful July, especially for any of them that disappoint regulators on both sides of the Atlantic.

More than 50 European banks are expecting results for their stress tests from regulators Friday. Some have already taken U.S. stress tests, and the majority are expected to meet approval in Europe.

However, the European Union examinations could mark the next step for the weakest among them to be either broken up or bailed out by their sovereign governments. Regardless, the tests are an important yardstick for how well banks have prepared for a crisis. Shareholders will closely watch the results.

It has been a more challenging year for European banks than for their American peers.

U.S. banks got off to a dreary start to 2016 as they took a hit from their exposure to energy companies and flagging commodity prices — though the banks' share prices have since rebounded. European banks are facing a far worse situation, factoring in the pain that's expected ahead as a result of the U.K. Brexit vote. Their test results could run across the board.

"We expect the more highly rated banks will show resilience," Alan Adkins, group credit officer with Fitch Ratings, said in sizing up the European banks.

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The European stress-testing procedures are, according to some, less stringent for banks than those of American regulators.

For example, EU testing procedures do not develop scenarios that take into account the assumption of negative interest rates — which was a part of U.S. stress testing this year. They do bear some resemblances to U.S. regulatory examinations, however.

"The adverse scenario included unemployment and also had rising long-term sovereign interest rates," Adkins said.

Some experts say EU banks, many of which do not face U.S. regulatory review, treat stress test results at home as if they were just as stringent as what banks must face in America.

"Although market stresses may look tougher in [the U.S. tests], it's hard to conclude one is tougher than the other," said Monsur Hussain, senior director with Fitch Ratings.

Under both U.S. and EU stress testing procedures, banks have to create capital plans that assume higher-than-current unemployment levels.

United States bank stocks that struggled to start the year amid difficult economic conditions regained much of the lost ground in recent months, but the same does not apply to some of the largest banks in the EU. Several EU banks have seen shares plummet by 30 percent to 40 percent this year, with little in the way of relief that's clearly apparent in the next few months.

A number of European banks are facing plunging revenue and cannot cut costs quickly enough to keep up, said Julien Jarmoszko, senior research manager with S&P Equity Research Services in London.

That includes Italian banks — which are under particular scrutiny because they are saddled with so many bad loans that their very existence is threatened — but also more systemically important banks. The latter group would include Deutsche Bank, whose Deutsche Bank Trust Corporation, the bank's U.S. transaction bank and wealth management business, was flagged by regulators in stress tests last month.

EU banks also face the issue of whether they are shrinking rapidly enough, and whether they can exist in their current form. Some, like Monte dei Paschi di Siena in Italy are facing questions about whether they can remain solvent while saddled many nonperforming loans. The idea that EU banks could kick off a contagion of failure is something regulators aim to eliminate.

Neither Deutsche Bank nor Monte Dei Paschi di Siena responded to requests seeking comment.