FRANKFURT, Germany (Reuters) -- Roughly one in five of the eurozone’s top lenders failed landmark health checks at the end of last year, but most have since repaired their finances, the European Central Bank said Sunday. The ECB found the most critical problems to be in Italy, Cyprus and Greece, but concluded that banks’ capital holes had since chiefly been plugged and that only €10 billion ($12.67 billion) remained to be raised.

Italy’s financial sector faces the biggest challenge with nine of its banks falling short. Monte dei Paschi had the largest capital hole to fill at €2.1 billion, even after its money-raising efforts this year.

The ECB’s exercise provides the clearest picture yet of the health of the eurozone’s banks more than seven years after the eruption of a financial crisis that almost bankrupted a handful of countries and threatened to fracture the currency bloc.

Although investors may take heart, it remains to be seen whether the exercise can spur banks to lend more as the region’s economic growth stutters to a virtual halt.

While 25 of the eurozone’s 130 biggest banks failed the health check at the end of last year with a total capital shortfall of €25 billion, a dozen have already raised €15 billion this year to make repairs. Italy aside, regulators said three banks in both Cyprus and Greece also failed to make the grade as of the end of last year.

A recent survey by Goldman Sachs Group Inc. of large institutional investors found they believed the ECB ought to ask lenders to raise an additional €51 billion of capital for the tests to be credible.

Once overvalued loans across the sector were taken into account, the ECB said the overall impact on banks was €62 billion.

Analysts gave the results a cautious welcome, but some cautioned it was only the beginning rather than the end of a banking cleanup in Europe.

“Although this should restore some confidence and stability to the market, we are still far from a solution to the banking crisis and the challenges facing the banking sector,” said Colin Brereton of PwC.

The exercise, which saw officials trawl through more than 40 million individual bank figures, has two parts -- a strict review by the ECB of assets such as loans, followed by a wider test of how banks would cope with a new economic crash. It is the fourth attempt by Europe to clean the stables of its financial sector and has been billed as the most rigorous.

Previous efforts failed to spot problems, giving lenders in Ireland a clean bill of health shortly before a banking crash drove the country to the brink of financial collapse.

“It is credible,” said Nicolas Veron of Brussels think tank Bruegel. “But it is only the start of a longer sequence of cleanup that will extend well into 2015.”

The ECB’s passing grade was for banks with high-quality capital of at least 8 percent of their risk-weighted assets, a measure of the riskiness of a banks’ loans and other assets, if the economy grows as expected over the next three years, and capital of at least 5.5 percent if it slides into recession.

Banks with a capital shortfall will have to say within two weeks how they intend to close the gap. They will then be given as long as nine months to do it.

A Corner Turned?

The ECB has staked its reputation on delivering an independent assessment of eurozone banks in an attempt to draw a line under years of financial and economic strife in the bloc. ECB Vice President Vitor Constancio said the exercise would ensure that “economic recovery will not be hampered by credit supply restrictions.”

But there is no certainty bank lending will pick up as the ECB hopes.

“Thinking that lending somehow can lead [gross domestic product] is an illusion, and I don’t know how that has somehow crept into the policy debate,” said Erik Nielsen, global chief economist at Unicredit.

For many banks, the biggest impact of the ECB tests was not in identifying capital holes but in finding that their assets, such as loans, had been overvalued. In total, the ECB said banks had been valuing their loans and assets at €48 billion more than they are really worth.

That accounted for €11 billion of the €25 billion banks were collectively short at the end of last year. It also eroded €37 billion of capital among the banks that passed, bringing the total impact on the sector to €62 billion.

Among the major listed banks, the biggest hits were to Greece’s Piraeus bank, whose core capital fell by 3.7 percentage points after the ECB adjusted the bank’s capital to reflect the new asset valuations. Monte dei Paschi’s capital was reduced by almost one-third, a figure that counts for almost €3 billion. There was also a big impact on Austria’s Erste Bank.

The adjustments put many banks in an uncomfortable position. Thirty-one had core capital of below the 10 percent mark viewed by investors as a safety threshold, while a further 28 were on the borderline with ratios just 1 percentage point above.

The ECB will not immediately force lenders with overvalued assets to take remedial action, but they will have to hold more capital eventually, leaving less room to expand, lend or pay dividends.

For lending, the more fundamental question is whether the demand for credit is there. The ECB is about to take on its new regulatory responsibilities, but it may be its monetary-policy powers that the eurozone needs most.

“Businesses need to believe in an increase in the demand for their products before asking for credits, and now that external demand growth is no longer there, this is when the eurozone needs demand stimulus,” Unicredit’s Nielsen said.

(Reporting by Laura Noonan and Eva Taylor; Additional reporting by John O’Donnell and Paul Carrel in Frankfurt, Huw Jones and Steve Slater in London. Writing by Mike Peacock and John O’Donnell, editing by Alexander Smith)