Market concerns about Spain's financial health eased this afternoon but questions emerged over a pledge by the EU to disclose the results of bank "stress tests" seen as crucial to restoring confidence in then euro zone.
The euro held at a three-week high against the dollar and the risk premium that investors demand to hold Spanish debt rather than German benchmark bonds fell to 193 basis points after hitting a euro lifetime high of 238 yesterday.
Spanish stocks also gained, with banking shares leading the way, after a successful Spanish bond sale yesterday and comments from International Monetary Fund head Dominique Strauss-Kahn voicing confidence in Madrid's reforms.
“There has been a slight change in sentiment,” said Mike Lenhoff, chief strategist at Brewin Dolphin Securities in London.
“It looks like the policy effort is beginning to come to fruition." Still, a pledge by the European Union to disclose the results of tests of whether banks have sufficient capital to cope with financial shocks came under close scrutiny.
The EU 27 leaders agreed to the move at a summit in Brussels yesterday after Spain and France threw their weight behind the idea. They promised to disclose the tests on a bank-by-bank basis by the end of July.
European Commission President Jose Manuel Barroso, speaking in Florence, said the resilience tests would involve "much more" than the 25 large institutions EU officials had said would be examined, raising the possibility that Germany's fragile Landesbanken and Spain's strained cajas could also be included.
Despite the EU pledge, some countries may struggle to force reluctant banks to disclose financial details they would prefer to keep secret. German law, for example, prohibits this.
Pressed on the issue, German Finance Ministry spokesman Michael Offer conceded that Berlin could not force banks to reveal test results, but hoped that peer pressure would convince them to be transparent.
It was also unclear what criteria regulators would use to perform the tests. A French official said scenarios used in tests so far did not include the risk of a sovereign default or debt restructuring in the euro zone.
A senior euro zone source said the tests would simulate a slowdown in growth and stress on sovereign holdings. Bundesbank president Axel Weber has urged Europe to proceed with a new set of tests that would include more drastic downside scenarios.
"If well executed, we think this is likely to help market confidence, although there are still plenty of open questions about how definitive these tests will be," said Morgan Stanley in a research note.
The US has been urging Europe to press ahead with transparent assessments of the health of its banks, a strategy used successfully by the President Barack Obama's administration to restore faith in Wall Street firms in the midst of the global financial crisis in 2009.
In a letter to fellow G20 leaders published today, Mr Obama pressed Europe to do more to address uncertainty over the balance sheets of its banks. Mr Obama also called on other major economies to boost private sector demand, just when Germany is pressing EU partners to implement strict austerity measures.
The EU conducted a stress test of its entire banking sector last year, but has resisted pressure to break down the results by country or bank.
While such tests could restore investor confidence in some banks, they could also force governments to recapitalise those that remain fragile - a move that would be highly unpopular at a time when citizens across Europe are facing steep budget cuts.
“In parallel with the publication of the individual results, if necessary, governments will be expected to say what course of action they can envisage,” the euro zone source said. "Under no circumstances would a bank that may be under distress be left out in the cold."
Reuters