Stressful time all round

I knew it wouldn't be easy to understand the results of the European bank stress tests, after Jim O'Neill said he wouldn't rush to give an opinion once the results were published. The chief economist of Goldman Sachs International, and one of the sagest voices in the business, said his team would probably digest the hundreds of pages over the weekend before coming to a conclusion on whether the tests had been worth it.

When the results started to be published last Friday I immediately saw what he meant. The headline number suggested all was well. We had been led to believe 10 or more would fail. But in the event only seven couldn't withstand a future economic storm, and they were the usual suspects.

Hypo Real Estate of Germany, ATE of Greece and five regional banks from Spain. All the big banks of the European Banking World had comfortably passed. We could sleep easily at night; Europe's banks were in a much better state than first thought. Hurrah!

And then the press releases began. Like proud parents showing off after receiving their children's school reports, each national banking authority spewed out spin about how clever and strong their little-banks were. Again and again, the authorities parroted the virility of their banks to withstand an economic hurricane in the future.

What was clear is that the stress tests weren't actually that stressful. Sovereign default for debt on the banks own books wasn't included as a scenario. And if you change the parameters, for instance, had the Tier One capital limit been seven and not six per cent then according to the investment bank Nomura, 24 banks would have failed.

Nor must it be forgotten that the continent's banks have been very busy revising for such tests. All the really big banks have been involved in capital raising exercises to shore up their balance sheets in the past 18 months.

While there is definitely more work to be done for the second and third level of banks, the really heavy lifting has been done.

For those sickly unfortunates whose Tier One capital would fall below six per cent under the testing scenario, extra help is on the way. The Caja's of Spain are in the process of merging. Hypo Real Estate of Germany is de-facto in government hands and ATE had been promised money from the Greek government to shore up its balance sheet.

Now the tests are over, we must surely prepare ourselves for the reality that in the future, banks must be allowed to fail (shock) and the banks' shareholders take the losses (horror.) The financial crisis was prevented from becoming a calamity because banks were bailed out. We had no choice. But if there is one thing that we have learned from this crisis it is that must not be allowed to happen again.

Of course governments must run individual deposit insurance schemes to protect ordinary savers who can't be expected to understand Tier One Capital limits. If a regulator authorises a bank, the relevant government must stand behind its deposits up to a reasonable amount. But the financial world does understand a bank balance sheet and now risk must shift from the taxpayer to the bank's investors and the market, where it properly belongs.

At the end of this long tortuous process I am still left with the fundamental question - are Europe's banks okay? I think I know the answer to that - yes, they are strong and getting stronger - but the truth is, even after all the song and dance over the stress tests, who knows?