Snap analysis: Divided EU did best it could on stress tests

BRUSSELS (Reuters) - Internal divisions prevented the European Union carrying out stringent enough tests of its banks to fully restore investor confidence in its handling of a sovereign debt crisis.

Results of the tests on Friday showed seven of the 91 European banks scrutinized would not withstand another recession, and went only some of the way toward rebuilding faith in its efforts to contain the fallout of the crisis.

Supporters of the 27-country EU, which has been heavily criticized during the debt crisis that started in Greece, say it did the best it could in securing agreement on the tests.

But because of political sensitivities it did not include the possibility of a sovereign debt default in a country such as Greece in the tests' criteria, a measure which many investors had seen as a benchmark for them to be honest and exhaustive.

Identifying any country as potentially vulnerable to bankruptcy could have dealt a political blow to its government and would have risked becoming a self-fulfilling prophecy if financial markets continued to be nervous.

"On the face of it, the results of the EU bank stress tests would seem to be fairly positive, but worries that the tests were not demanding enough will persist," said Jennifer McKeown, senior European economist at Capital Economics.

The EU would have liked more praise of its efforts but has gone some of the way to winning over investors' confidence in the last few weeks, partly by announcing at a summit in June 17 that it would hold the stress tests.

That announcement followed agreement on a 500-billion euro ($644-billion) rescue fund to help euro zone countries in trouble stave off any risk of a sovereign default.

INVESTORS' CRITICISM

But before the publication of the results, many investors criticized the way the exercise was being prepared, citing secrecy about the criteria that probably resulted from haggling among governments and banks on what exactly should be disclosed.

"Arguably the failure here is not the banks concerned, but the test itself," said Richard Cranfield, Chairman of Global Corporate Group at international law firm Allen & Overy.

"There is little evidence that the tests have been applied consistently and there is a distinct lack of credibility, making this a wasted opportunity."

It was no accident that during the preparations for the tests, Germany -- the euro zone's biggest economy -- generally backed more secrecy and a less transparent approach.

This is because however weak some of its banks proved to be, they could ultimately be protected by a well-funded government.

By contrast, Spain sought thorough tests, despite the risk of some of its banks failing. Analysts said this could give it the justification, in the eyes of its tax payers and EU state aid watchdogs, to recapitalize its vulnerable banks.

But despite the divisions, the EU negotiating machine did lumber along, producing the results barely a month after the plans for the test were announced. It moved unusually quickly considering that unlike the United States, is not a federal state and is dogged by internal rifts.

EU national governments, the European Central Bank and the executive European Commission sought a balance between disclosing enough details about the banks' financial health to make the exercise credible but avoid criteria that were so tough they would scare investors.

Even if the stress tests are deemed on Monday, when the markets open, to have been too modest and conducted too late, they will be a lesson for the EU for any future crises.

This could strengthen arguments in favor of a more centralized approach to financial supervision, an issue now being discussed by the EU's national governments and the European Parliament.

(Editing by Andrew Roche)