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Exclusive: EU states ready to rescue bank test failures

By John O'Donnell

BRUSSELS (Reuters) - European governments are ready to bail out those banks which cannot raise capital from investors after the EU details on July 15 which lenders have failed its latest, more vigorous stress test.

The European Banking Authority (EBA) announced on Friday the publication date for the results of its check on 91 of the region's top lenders. These will be accompanied by measures to bolster capital for those that failed or nearly failed, in another attempt to reassure investors that European banks can withstand future shocks.

According to a separate European Union draft document seen by Reuters, European countries will support banks that fail the stress tests if those lenders cannot raise capital from investors within six months.

The paper, being prepared for EU finance ministers to approve on Tuesday, is an about-face from promises by G20 policymakers in the wake of the financial crisis that taxpayers would never have to bail out banks again.

An official close to the EBA said all banks that fail must have a plan by September to plug the capital shortfall by the end of this year, as previously agreed by EU finance ministers.

Those just above the pass mark will be more closely scrutinized and must also plan remedial actions but their implementation deadline remains unclear and could be clarified by finance ministers next Tuesday, the official said.

Member states will be obliged to have backstops in place only for banks that actually fail the test, the official added.

European Banking Federation Secretary General Guido Ravoet said some banks may struggle to find enough capital.

"Is the European financial market deep enough to respond to the needs for capital? We are not the only sector looking for capital," Ravoet said.

PRESSURE ON PERIPHERY

This latest round of tests has been touted as being more rigorous than previous attempts, in which few banks failed, and finance ministers' officials are drawing up plans for how to deal with the fallout.

The EU document also says lenders that nearly fail the tests will be put on a critical watch list in case they deteriorate.

Sources close to the banks and watchdogs said all German banks were certain they would get the green light, although some lenders, including publicly owned landesbanks HSH Nordbank and NordLB, would just scrape through.

News that EU governments appear serious about supporting banks that fail to maintain core capital of 5 percent in the face of several theoretical markets shocks lifted Bund futures and UK gilts.

"In essence that puts even more pressure on the periphery (euro zone countries) to come up with measures, not only to shore up their budgets, but to support their banking sectors, which they can ill afford to do," said Marc Ostwald, strategist at Monument Securities.

"It's basically a charge to safety on the back of this. This is a market which is living in mortal fear of anything to do with the euro zone and anything that puts the banking sector under more stress," Ostwald said.

The Italian/German 10-year yield spread hit fresh euro-era highs amid fears that already fiscally stretched countries like Italy might have to dig into their pockets to bail out banks that fail the test as well.

Shares in Italian bank UniCredit fell more than 5 percent on fears that Italy could be pulled into the debt crisis that has already forced Greece, Ireland and Portugal to take bailouts. UniCredit is the only big Italian bank that has not yet announced a capital increase.

Italian banking association chief Giuseppe Mussari, when asked about possible government intervention for banks failing the stress test, said this was not an issue for Italian banks.

According to the draft EU document, capital-raising plans should first be based on "private-sector measures, including ... retained earnings ... raising additional common equity or high-quality hybrid instruments from private investors, assets sales, mergers."

But if the search for private capital leads nowhere, then governments should be ready to step in.

Officials do, however, make provision for "the extreme case" if efforts to rehabilitate a bank fail and it threatens wider stability, recommending "a process of orderly restructuring and resolution."

The number of banks declared by the EBA to have failed will either encourage investors that Europe is now coming clean with its banking problems, or if the tests are deemed too lax again, they will hurt the EU's already battered credibility.

Previous stress tests were widely dismissed as too lax -- with Ireland given the green light just months before the EU and International Monetary Fund had to bail its lenders and the country out.

PRIME SUSPECTS

Unlisted banks in Spain and Germany and a batch of banks that are already raising funds are the most likely to fail this year's health check, analysts at Nomura said.

Jon Peace, banking analyst at Nomura, said he expected few failures among the listed banks, and many of those who will fall short have raised capital this year or were in the process of doing so.

"We think it (failures) will be heavily skewed toward the unlisted banks in Spain and Germany and with some Greek banks in there. For large listed banks there will be few failures."

Nomura analysts said several banks could have a core Tier 1 ratio of under 5 percent under an adverse scenario based on end-2010 capital levels, including Spain's Bankinter and Sabadell, Italy's Banco Popolare; Greece's Piraeus and ATEbank; Cyprus-based Marfin Popular and Bank of Cyprus; and Bank of Ireland and Allied Irish Banks.

The new checks will measure how well the core capital that banks rely on to absorb losses such as unpaid loans holds up when exposed to an economic dip or fall in property prices.

They also gauge the impact on banks should government bonds they own, issued by states such as Greece, lose value.

For copy of the questions banks must answer in the stress test click on http://r.reuters.com/bet52s

(Additional reporting by Ana Nicolaci da Costa, Huw Jones and Steve Slater in London; writing by Sophie Walker; Editing by Will Waterman, Alexander Smith and Erica Billingham)

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