As Europe slogs through its latest round of bank stress tests, a growing number of analysts have already reached their own conclusion: Eurozone banks need additional cash. To buttress their case, some analysts have dusted off an obscure American bank metric that highlights the extent to which Europe’s increasing number of nonperforming loans is threatening to overwhelm existing bank cushions.
The measure, called the Texas ratio, was developed by an analyst who covered troubled United States banks during the late 1980s and early 1990s. During that period, numerous Texas-based financial institutions collapsed under the weight of faulty real estate loans.
Part of what has made the Texas ratio attractive to analysts and regulators is its simplicity. When the ratio of bad loans to equity and cash set aside exceeds 100 percent, it suggests that the bank is either ready to fail or is in desperate need of new capital — as was the case with Texas banks in the 1980s.
“We found it to be a very good guide telling you which banks would fail,” said Gerard S. Cassidy, the bank analyst who introduced the formula and coined the name. “It’s a ratio that everyone can understand.”
Now as the European Central Bank prepares to become the primary bank regulator in the eurozone, the extent to which lenders in troubled economies like Spain, Italy, Portugal and Greece have sufficient cash to protect against ever-rising bad loans has emerged as a crucial question for investors, banks and regulators.
The E.C.B. will publish the results of its half-year investigation into Europe’s 128 largest banks on Oct. 17. But until then, with worries mounting that the central bank will come down hard on banks with particularly weak loan books, investors and analysts have been scrambling to determine which of these lenders are most at peril.
And with European banks sharing similar characteristics with Texas banks in the late 1980s — nonperforming real estate loans and slim cash buffers — the Texas ratio has emerged as a popular analytical tool.
This spring, banking analysts for Nomura in London used the Texas ratio to highlight 11 banks in Southern Europe that were most exposed to nonperforming loans relative to cash they had on hand.
Of the 11 banks that exceeded the 100 percent threshold, three banks stood out with ratios of 150 percent and above: Piraeus Bank in Greece, Banco Popolare in Italy and Banco Popular Español in Spain.
Mr. Cassidy, who covers United States financial institutions for RBC Capital Markets in Portland, Me., does not pretend to be an expert on European banks — although he still uses the measure to examine American banks. But he is not surprised that his peers covering banks in troubled eurozone countries have started to use it.
It is a great way, Mr. Cassidy said, to ask the most important question a bank analyst or investor will ever want answered: Does the bank have enough money?
Of course, like all financial formulas, the Texas ratio is not infallible. For example, Banco Espírito Santo in Portugal, which collapsed two months after the Nomura report came out, was not listed as a bank with a ratio in the danger zone. And there is no sign yet that Piraeus or the other two banks are in dire straits, despite bad loan burdens that exceed their peers.
Moreover, Piraeus in Greece and Popular in Spain have both been subjected to particularly intense scrutiny of late by private sector stress tests undertaken to calm fears about the banks in these countries.
Still, as concerns build that weak banks will be forced to raise more cash as bad loans increase, investors — once eager to pile into these stocks, based on recovery hopes — have reversed course. Since early June, Piraeus and Popolare in Italy are down by a quarter, while Popular in Spain has lost 16 percent.
Using the Texas ratio also underscores the ever-increasing gap that separates European banks from their American counterparts, highlighting as well the contrasting approaches taken by bank regulators here and in Europe.
According to the most recent data, the average ratio for all United States banks is 15 percent, with giants like JPMorgan Chase and Citigroup boasting very healthy metrics: 16 percent for JPMorgan and 13 percent for Citigroup.
By contrast, the largest banks in the eurozone that also pretend to have global ambitions have much higher ratios — and arguably would be considered to carry more risk. Santander and BBVA in Spain have ratios of about 70 percent; UniCredit in Italy comes in at 90 percent; BNP Paribas has a lower measure of 41 percent. Deutsche Bank in Germany has one of the lowest scores in Europe, at 14 percent, but that understates its risk because most of its assets comprise riskier traded securities like derivatives and bonds.
For more than two years, outside analysts have argued that European banks, compared with their American peers, suffer from a fundamental capital deficit. Adrian Blundell-Wignall, who oversees financial research at the Organization for Economic Cooperation and Development in Paris, has been one of the more vocal critics in this regard.
And last year, economists at the Danish Institute for International Studies came out with a report highlighting how low cash buffers were in European banks, especially in France and Germany.
Since 2010, European regulators have sponsored two comprehensive stress tests, both of which were discredited after banks failed soon after each was completed.
Local central banks in countries hardest hit by the crisis — Spain, Ireland, Cyprus and Greece — have hired outside financial firms to run independent stress tests.
In Cyprus and Greece, these reports have drawn criticism over their independence. The most recent of them, a comprehensive study issued in March by BlackRock, which estimated Greek banks would need only 6 billion euros in new cash, has been criticized by one of Greece’s primary creditors, the International Monetary Fund, as being too upbeat.
“The picture they have painted is too optimistic,” said Jens Bastian, an Athens-based financial analyst. “The events on the ground do not support these optimistic scenarios.”
Mr. Bastian worked recently for the so-called troika — the E.C.B., the European Commission and the I.M.F. — overseeing Greece’s finances. And he points out that in the March BlackRock report, nonperforming loans in Greece were estimated at 28 percent.
Now, he says, “we are way beyond that level and have passed above the 34 percent threshold, totaling approximately 75 to 77 billion euros.” One senior Greek banker, who spoke on the condition of anonymity, said that he was expecting the E.C.B. to require the top four banks in Greece to raise from 5 billion to 8 billion euros.
Greek officials have said that in such a situation, the banks could tap international markets, as Piraeus and others did successfully earlier this year. But with nonperforming loans pushing ever higher, and with investors more cautious about investing in risky European banks, securing the needed cash may not be so easy this time around.