European supervisors shored up some confidence in the stress tests they are imposing on banks, as markets focused on finding out more detail about the process before delivering a final verdict.
The regulators are aiming to restore trust among bank investors, in the same way that U.S. stress tests last year helped draw a line under problems there, publishing a list of 91 banks subject to the tests late on Wednesday.
The Committee of European Banking Supervisors (CEBS), tasked with running the tests, said that it would test banks' resilience assuming economic growth 3 percent below official Brussels forecasts.
Pascal Decque, an analyst at Natixis, said it was good that the tests would cover a wide scope of banks, including Spain's cajas and Germany's landesbanken, and that the tests would be published on a bank-by-bank basis.
European bank shares rose roughly in line with overall markets, in a sign that the tests were not worse than what markets had been expecting, even if many analysts criticized a lack of detail.
The bad news is that there are very few details on the assumptions, especially on sovereign. In reality, nothing, said Decque.
European investors have been shaken by worries about sovereign debt losses, more bad debts and doubts about the health of the unlisted bank sector.
The European test, whose results will be released on July 23, will include losses on some government bonds based on a deterioration of market conditions to worse than the situation observed in May.
But details of the stress test were limited, including on the scale of markdowns on sovereign debt.
A markdown of Greek debt would be 16 to 17 percent off the market price, German industry sources said before the CEBS statement. No markdown would be applied to German sovereign bonds, the sources said, and a 0.7 percent markdown would be applied to French sovereign bonds, one source said.
That would not be onerous enough, said Andrew Lim, analyst at Matrix.
Stress should be a worst case scenario and this is not a worst case scenario by any stretch of the imagination ... there's a very real possibility of debt restructurings having to take place for sovereign debt, Lim said.
Short term the market is positive on the fact that most of the banks should pass it. But longer term investors will come to the conclusion that the tests weren't onerous enough.
By 1259 GMT the STOXX Europe 600 bank sector index <.SX7P> was up 1.99 percent, adding to a near 8 percent rally over the last two days, also helped by positive comments by analysts at Credit Suisse and gains by U.S. peers.
Gainers were led by France's BNP Paribas and Societe Generale and Royal Bank of Scotland , all up over 2.6 percent.
TRANSPARENCY KEY TO SUCCESS
Most of Europe's large banks are on the list to be tested, as well as regional landesbanks and cajas, thought to be among the weakest.
The purpose of the stress test is to differentiate between the listed and the unlisted banks. That's deliberately the case in Spain, but reluctantly the case in Germany, said Simon Maughan, analyst at MF Global.
The elephant in the room in European banking is the awful German domestic market. The Germans don't feel the same political and economic pressures as the Spanish to do anything about it, but that's what the stress tests will show, he said.
European regulators appear to have heeded some lessons from the 2009 U.S. stress tests, which were widely regarded as a success in helping restore confidence. CEBS needs to go further in making the process more transparent, analysts said.
U.S. investors took comfort that a line had been drawn under potential exposures to worsening bad debts.
While the American tests reduced fears of more structured credit losses, the key for Europe is to reduce worries about sovereign debt exposures, analysts have said.
Regulators also need to make clear if banks will raise capital privately or if there is a government backstop available for any bank shown to be short of capital.
Under the U.S. test, 10 of the 19 banks tested were found to need to raise $185 billion. After asset sales of restructuring the capital need was about $75 billion. The banks were told to raise capital or accept taxpayer help.
The U.S. test process helped a recovery in bank stocks. The KBW bank index <.BKW> rose 30 percent from the start of February -- just before the tests were announced -- to the end of May, after the results came out. The index rose by half through to the end of 2009, albeit aided by other supportive factors.
(Additional reporting by Paul Day In Madrid; Editing by Sharon Lindores)