UCG Unicredit Spa

By Max Colchester and Jenny Strasburg in London and Deborah Ball in Milan 

European regulators gave most banks a clean bill of health in "stress tests" despite the Continent's sluggish growth and low interest rates, saying only a clutch of lenders would struggle to ride out a hypothetical severe economic downturn.

The European Banking Authority released results Friday of its latest stress test showing how much capital, or cushion against losses, banks would have left on their balance sheets in an adverse economic scenario. The tests come after European banks climbed out of the 2010 eurozone crisis but have continued to grapple with low profits, bad loans and, sometimes, management problems and turnover, all of which have translated into struggling stock prices.

Struggling Italian lender Banca Monte dei Paschi di Siena SpA was at the bottom of the pack of 51 banks assessed, underscoring investor sentiment that the bank is a worrisome vulnerability in the country's system and needs to raise substantial funds.

Other major banks that suffered sizable hits to their capital buffers included UniCredit SpA, Barclays PLC and Deutsche Bank AG.

Hours before the results were made public, the board of Monte dei Paschi unveiled a plan to unload nonperforming loans and raise up to EUR5 billion ($5.54 billion) in capital. Because the Siena-based bank was expected to be the worst performer in the test, its management was eager to come up with a plan to head off a crisis of confidence following release of the results.

The bank said the tests didn't take into consideration its new plan to raise capital and unload sour loans.

The European Central Bank said the exam used a less severe scenario than the toughest one used in stress tests for U.S. banks in June, in which 31 out of 33 U.S. lenders, including big firms such as Bank of America Corp. and Citigroup Inc., passed. In addition, the European Union tests didn't include struggling Greek and Portuguese banks this year, which could help account for the relatively rosy results despite Europe's woes. Such lenders are being privately tested by regulators, and the results won't be made public.

In addition, the banking authority's toughest economic scenario didn't factor in negative interest rates or the effects of a U.K. pullout from the EU. Regulators said the scenarios tested were gloomier than most of the predicted impact from the Brexit vote.

Unlike in previous European stress tests, regulators didn't include a pass or fail result for each bank related to a specific capital amount. Instead, the EBA has left it up to investors and regulators to interpret the results.

Broadly, investors were looking for banks to maintain at least a 5.5% ratio of top-quality capital in the test scenario, analysts said.

Of the "systemically important" European banks, Italy's UniCredit fared the worst, with a ratio of 7.1%. U.K. bank Barclays had a capital ratio of 7.3%.

Deutsche Bank had a 7.8% capital level, better than some analysts had expected. Investors had been concerned that the German lender could face an ill-timed capital crunch. The results show that Germany's largest lender by assets must continue to cut costs and reduce risky assets to boost its buffer against losses.

Deutsche Bank Chief Executive John Cryan said the test showed the bank is "well equipped for tough times" and on track to reach capital goals in its turnaround plan.

UniCredit said it would take the results into consideration as it develops its new strategic plan.

Some analysts said they had expected Barclays to meet a higher capital ratio threshold of 7.5%.

Such an expectation potentially raises pressure on the bank to bolster its balance sheet. It said was focused on a separate Bank of England stress test expected later this year.

Swiss banks UBS Group AG and Credit Suisse Group AG aren't part of the eurozone and weren't included in the stress tests.

Generally, the test was a glimmer of good news for U.K. banks, whose share prices have been depressed following the country's vote to exit the EU in late June.

"The results demonstrate that the extensive banking reforms since the financial crisis are working," said Anthony Browne, chief executive of the BBA British banking group.

Monte dei Paschi's capital buffer, which was calculated before the bank unveiled its overhaul plan on Friday, was totally wiped out by the test scenario. Its poor results underscore the importance of carrying out its new plan, which includes unloading EUR9.2 billion in net nonperforming loans to Atlante, a fund orchestrated by the government and financed by Italian banks, insurers and pension funds. The plans still needs regulatory approval.

Ireland's Allied Irish Banks PLC also came in under the 5.5% bar, with a capital ratio of 4.3%. All the other banks came in at over the 5.5% hurdle.

Individual countries' regulators will use the numbers to calculate each bank's capital requirement later in the year. Underperforming banks could be guided to hold more capital, but authorities are unlikely to widely force banks to raise more funds. Alternatively, banks could face tougher "qualitative measures" such as improving risk controls.

Write to Max Colchester at max.colchester@wsj.com, Jenny Strasburg at jenny.strasburg@wsj.com and Deborah Ball at deborah.ball@wsj.com

(END) Dow Jones Newswires

July 29, 2016 19:08 ET (23:08 GMT)

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