How Europe's banks will raise more capital and how their governments will help plug large holes in banks' books will be the main focus of ministerial talks in Brussels this week.
Finance ministers gathering in Brussels today (12 July) will take a further look at bank rescue plans ahead of the publication of stress tests next week.
The EU's economy commissioner, Olli Rehn, believes beleaguered banks should be able to tap into the Union's 440bn euro bailout fund, which was set up after the euro zone had realised the severity of Greece's debt problems.
However, senior EU sources say the fund could not be implemented to rescue banks as it was designed to rescue governments.
Ministers will also try to forge a long-awaited compromise on new EU supervisory authorities and decide whether these will have the power to tell deviant financial companies what to do when a national regulator fails to do so (EURACTIV 07/0710).
Stress tests in three steps
The stress test results are due for publication on 22-23 July, according to EU sources, and will span a total of 91 banks or 65% of the European banking sector.
The list of tested banks was stretched from the original 25 major banks to include Germany's regional Landesbanken, Spain's cajas and other unlisted banks which have been earmarked by investors as possible recipes for disaster.
Sources from the EU's Council of Ministers say the tests will be published in three phases in one day.
First, the Committee of European Banking Supervisors (CEBS) will publish aggregate results of the tests, the source explained. Second, national supervisors will publish results for individual banks and third, governments will make statements on recapitalising banks "where necessary".
What is at stake?
Ministers will also discuss "what is at stake with the publication of results and the co-ordination of communication strategies," according to a note circulated before the meeting.
Early estimates from Credit Suisse put the total recapitalisation costs of EU banks at 90 billion euros, with German Landesbanken and Spanish savings banks getting the largest share at 37 billion euros and 12 billion euros respectively.
Although methodologies have been far from transparent, the tests are expected to calculate banks' resilience against a 3% drop in GDP and against a markdown in sovereign debt, which would be a 16-17% drop in the case of Greek borrowing.
Tests not good enough
Critics argue that such a drop does not represent a default by Greece, a factor that they argue needs to be included for the tests to appear credible to market forces, which are are taking a Greek default seriously.
"We cannot rule out that Greece could go bankrupt before the end of this year and that it is increasingly likely that we are looking at a restructuring of debt for sovereign bond holders," argues financial analyst Kevin Newman (EURACTIV 02/07/10).
"Stress should be a worst-case scenario and this is not a worst-case scenario by any stretch of the imagination […] there's a very real possibility of debt restructuring having to take place for sovereign debt," said Andrew Lim, an analyst at Matrix.
"Short-term the market is positive over the fact that most of the banks should pass it. But longer term investors will come to the conclusion that the tests weren't tough enough," Lim added.
In addition, analysts argue that it is impossible to get a true picture of the likely losses if a country were to default on its debt because the European Central Bank has been buying sovereign debt to help prop up prices.
"There is not a whole lot of point doing these tests as the methodology and the transparency is not going to be robust," argues Newman.
"You only have to look at the amount of liquidity the ECB [European Central Bank] is giving banks to know that large swathes of the European banking sector are in danger of becoming insolvent," Newman added.