Leaked preliminary results of US government stress tests on banks suggest the financial crisis is far from over

Citigroup and Bank of America have both been told that they must raise billions of dollars of extra capital, according to a report that suggests the financial crisis is far from over.

The Wall Street Journal reported today that the stress tests conducted by the US government on 19 banks found that both Citi and Bank of America need more funds to cover future losses caused by the economic downturn.

The US government conducted the stress tests in an attempt to identify which financial institutions are well-positioned to ride out the slump and which are too burdened by toxic assets and bad debts. Both banks are said to be disputing the preliminary findings. The final results of the stress tests are due to be published next week.

The report sent shares falling in Asia, and European markets also opened lower. The FTSE 100 index tumbled almost 70 points within the opening minutes of trading, to 4101.94, with banks among the biggest fallers. Traders warned that if Citi and Bank of America are both short of funds then other banks might also need to increase their own capital reserves.

The swine flu crisis also hit markets and airlines and travel companies saw their shares fall further.

In Tokyo, the Nikkei fell by 2.7% to 8493 points, its lowest close in four weeks. In Hong Kong, the Hang Seng index dropped 2.5% in late trading with Cathay Pacific down 8.0%, Air China off 13% and China Southern Airlines falling 15%. Luxury hotel operator Shangri-La dropped 8.7%.

UBS analyst Damien Horth believes the swine flu outbreak could be very damaging for the airline industry, which is already suffering from the economic downturn.

“The danger is that this outbreak undermines a potential recovery in demand [in the second half of 2009],” Horth warned.

According to the WSJ, banks which are asked to raise more capital following the stress tests will not be declared insolvent. Analysts had already predicted that several other companies, such as Wells Fargo and some regional banks, would perform poorly on the tests. The Federal Reserve asked banks to estimate their losses based on several economic scenarios, in which GDP, unemployment and house prices fell by varying amounts.

Both Citi and Bank of America are under heavy pressure from shareholders, despite posting better-than-expected results for the first three months of 2009.

At Citi, chief executive Vikram Pandit has been criticised for not cleaning up its balance sheet faster. Bank of America’s boss, Ken Lewis, could be ousted as chairman at an annual general meeting tomorrow. Investors are furious that Lewis paid $50bn (£35bn) for Merrill Lynch before it became clear quite how much Merrill had lost in the crisis.