One of Europe’s newer traditions consists of regulators “stress-testing” banks to ensure they would not fail, or require a taxpayer-funded bailout, if the economy were to sour quickly. The latest probe into the viability of around 130 banks was released on October 26th, showing that 25 of them failed stress tests. About half of those had already taken actions to remedy their alleged failings, so are basically fine. But nine of the banks that failed are in Italy, and most of the other problematic lenders are in Southern Europe.



Will markets care? The results in terms of number of failures is slightly worse than expected, though most of those are tiddlers who failed by relatively small amounts. But even those that have passed are not invincible. Another European tradition, sadly, is for those banks declared fit in past stress-tests to topple over soon after, an unwelcome trend that exacerbated the euro-zone crisis.

But this time is different, the organisers say. Part of the “comprehensive assessment”, as it is dubbed, is a traditional stress-test of the sort that has been carried out before with mixed success (the aim is to model what happens to a bank if house prices tumble or markets convulse, checking that it remains solvent). Organised by the European Banking Authority, this covers big banks in all 28 of the European Union's member states. But there is no reason to expect that the test itself will give better results than past exercises.

The new bit is more interesting. The European Central Bank (ECB) simultaneously to the stress-tests has carried out a comprehensive audit of the value of the stuff on each bank’s balance sheet, the Asset Quality Review (AQR). This was only applied to 123 big banks in the euro zone's 18 countries, which from next month will be regulated by the ECB instead of national watchdogs. It has staked its credibility as a regulator on its ability to gauge the health of Europe’s banking system at the time it inherits it.

Thousands of bank employees, consultants, auditors and other white-collar types have been probing for much of the past year. The biggest asset pile of most any bank is its loan book, the money its customers have borrowed and should, in theory, repay. The value of those assets largely depends on whether they actually will repay it—a loan extended to a firm that is nearly bust is not worth as much as a loan to a healthy one. The value of collateral put up for the loan, such as a house in the case of a mortgage, also needs to be assessed.

The ECB found €136 billion in troubled loans banks had not already confessed to owning, bringing the European total to €879 billion ($1.1 trillion). Italy will have to implement the biggest reclassification of loans (€12 billion), with Greek (€8 billion) and German banks (€7 billion) also challenged. Interpreting the results, even at aggregate level, is complicated by the fact that they are arrived at using data from the end of 2013—and much has happened since then. Notably, many banks that thought they might fail the tests have raised over €45 billion in equity, strengthening them considerably. That explains why only 13 banks will have to unveil plans to raise capital when 25 have apparently failed, including Eurobank in Greece, Monte dei Paschi di Siena in Italy and Portugal's BCP, the only three with more than €1 billion to raise. They now have to come up with plans to strengthen their balance sheets.

How the markets reaction will be key (the test results were released on Sunday for that reason). Policymakers are hoping for a cathartic moment for Europe’s lenders, of the sort experienced by American banks after their 2009 tests. American finance rebounded quickly while Europe stalled. It looks like the ECB opted to accept a bit of market nervousness in the short term as a price to pay for establishing its credibility. Though this has not been announced, most of those who failed were smaller outfits not widely known outside their own borders. Some bankers may now see an opportunity to buy or merge with a rival, now that the ECB has given its verdict on the quality of its target’s assets.

But the biggest impact in the long term will be on the perception of the ECB. After the Eurozone crisis, it is now regarded as the most credible institution in Europe at the moment—although admittedly competing in a field of pygmies. Its taking over of European banking supervision is a key plank of the “banking union” that was devised to end the Eurozone crisis—ensuring that Italian banks are well regulated, say, is a pre-requisite for Germany agreeing to bail them out through pan-European mechanisms in future. So if the AQR and stress-tests enhance the ECB’s stature, and it can reassure markets that all is well with European banks, much will have been achieved.