European banks largely passed a round of government stress tests, with just a few institutions found to need modest amounts of new capital.
But the overall strong grades, awarded to a banking system that for the last several months has lurched from crisis to crisis, raised questions over whether the month-long tests were tough enough to be judged credible.
The stress test results, intended to restore trust in the European banking system, showed that the 91 banks scrutinized could face €566 billion in total potential losses in a deteriorating economic and financial environment.
The tests found that seven banks would need to raise new capital to fortify their finances and weather a potential economic downturn or government bond crisis.
Five Spanish banks, one German bank and one Greek bank were the only institutions to fail the tests. Their combined shortfall would be about €3.5 billion, according to the Committee of European Banking Supervisors, which coordinated the tests.
By contrast, analysts had estimated that the exams could reveal capital shortfalls totalling anywhere from €30 billion to €90 billion.
Investors quickly deemed some of the tests' terms insufficiently onerous. As details of the test methodology trickled out Friday, the euro fell back from early gains to trade lower against the dollar. European bank stocks, strong during the week, retreated in New York trading.
Last October, Greece's worsening fiscal situation stoked fears that the European Union member could default on its debts, igniting a continent-wide crisis of confidence that entangled neighboring countries, dozens of banks and even Europe's common currency. Attempted fixes, including a $1 trillion rescue fund announced in early May, provided only temporary respites.
Market confidence in Europe's banks and governments recently has improved, partly due to optimism that the stress tests, which last year helped ease the U.S. banking crisis, would work similar wonders in Europe. The cost of insurance on government and bank debt has fallen, the euro has rallied, and bank shares have jumped.
But in a sign of persistent problems stalking Europe's financial institutions, many banks are struggling to borrow money from traditional market sources and instead have grown increasingly reliant on the European Central Bank as a source of daily funding.
Regulators from 20 countries had to walk a tightrope in engineering the tests, whose terms have been cloaked in secrecy. Overly harsh tests could cause dozens of banks to flunk, fueling a panic. But lax standards would lack credibility.
Investors on Friday reacted negatively to news about the tests' terms, sending the euro lower versus the dollar. Among the concerns was that regulators used a narrow approach to examine the impact that a sovereign-debt crisis would have on the banks, focusing solely on the impact on their short-term trading books rather than on the entirety of their balance sheets.
While much focus has been on which banks will pass the tests, the pivotal details likely will reside in each bank's disclosures of how much government debt it's holding from shaky European countries.
Investor anxiety about banks sitting on untold billions of potentially risky "sovereign" bonds helped spark the European banking crisis. Now European officials are hoping the public disclosures of each bank's sovereign-debt portfolios will help quell those fears. But the greater transparency also could highlight previously unknown vulnerabilities in parts of the banking system.
The tests' capacity to resolve the intertwined banking and euro-zone crises is limited partly because of the dire fiscal situations facing many E.U. countries whose economies are in the doldrums. That's problematic because European banks not only own tens of billions of dollars of their governments' debts, but they also have relied on the governments to bail them out in times of crisis.
"At the end of the day, you need the sovereign stress to be resolved in order to fully solve concerns about banks," said David Mackie, European economist at JPMorgan in London.
Illustrating the situation, Moody's Investors Service on Friday placed Hungary's sovereign debt rating on review for a possible downgrade and then warned that it also might slice the ratings of seven Hungarian banks.
The 91 banks subjected to the E.U. stress tests range from the U.K.'s HSBC Holdings PLC, with $2.4 trillion in assets and about 8,000 branches, to Malta's Bank of Valletta, with €6 billion in assets and 41 branches.
Combined, the banks hold nearly two-thirds of the assets in Europe's banking system.
From the start, the stress tests have been dogged by doubts. The Committee of European Banking Supervisors, a tiny London-based group that is coordinating the tests, has struggled to corral regulators from 20 countries. Disagreements have flared over issues ranging from the severity of the tests to how and when their results should be announced.
A particular flashpoint: the politically charged question of whether the tests should look at the impact of a European Union member defaulting on its sovereign debt. Such an event - which many investors consider plausible - would cause losses for any institution holding that country's bonds, and many European banks own bonds issued by countries like Greece, Spain and Portugal.
The tests ultimately didn't look at the possibility of a sovereign default - an omission that is likely to emerge as a chief criticism of the exercise.
Investors, bankers and even some regulators are worried that the stress tests aren't sufficiently rigorous or transparent to calm frayed nerves. Some European regulatory officials were stunned this week by public statements by senior Greek officials that their six banks would pass the tests.
The risk is that "traders and investors may even take the view that the authorities are covering up weaknesses among the banks by carefully structuring their stress tests and limiting them," said Carl B. Weinberg, chief economist at High Frequency Economics, in a research note.
Still, the results are likely to highlight the diverging fortunes of banks across Europe.
While the published results don't rank the banks, each lender must disclose its potential losses and so-called Tier 1 capital ratio in the event that Europe's economy shrinks for each of the next two years and government bonds lose value. Some U.S. banks plan to trim their lending exposures to European institutions that don't fare well under the exams.
The results "will create a league table of European banks ranked in terms of capital adequacy, where the weakest will be stared at by the eyes of the market," said Gerard Fitzpatrick, a portfolio manager at Russell Investments. "This will lead to an ever greater challenge to the profitability and potential survival for such banks."
The European stress tests were modeled on the tests that U.S. regulators conducted last year of 19 top banks. Those tests, though controversial at the time, are now seen as a turning point in the U.S. crisis.
Today, the U.S. is far ahead of Europe at mending its banking system. Most large U.S. banks received and have since repaid taxpayer funds. Even as the U.S. economy remains weak, a parade of banks this month announced strong quarterly results, partly because they set aside so much money in past quarters to deal with future losses.
In Europe, it's unclear how banks that are found to be capital-deficient will plug the gaps. Greece, Spain and Germany have bank-bailout funds, which lenders could tap if they can't raise funds privately. Analysts and investors have suggested that banks in other countries might be able to enlist their governments to take funds from a European bailout pool and transfer those funds to the banks.