The number of banks that failed the test and the size of their capital shortfall were in line with expectations after news leaked on Friday that 25 lenders would flunk the year-long review.

With no major bank caught short and a relatively small capital hole to fill, markets were expected to take the results in their stride although Italian bonds and bank shares could come under pressure on Monday after Italy dominated the losers list with 9 lenders failing the tests.

"I think stocks, broadly speaking, will have an up day tomorrow. While there were no major surprises in terms of who passed and who failed, there was still an element of uncertainty and so it’s positive for the market that we get this exercise, which has been dragging on for year, behind us," said Philippe Bodereau, head of global banking at PIMCO.

“It’s meaningfully positive for market sentiment."

Twelve of the 25 failing banks have already covered their capital shortfalls after raising a collective 15 billion euros (11.81 billion pounds) his year and of the remaining 10 billion euros, nearly a third of that should be raised via restructuring plans already in place for Greek lenders Eurobank (>> Eurobank Ergasias SA), Piraeus (>> Piraeus Bank SA) and National Bank of Greece (>> National Bank of Greece).

Monte dei Paschi (>> Banca Monte dei Paschi di Siena SpA), Italy's third-largest bank, was the biggest loser, with a capital hole of 2.1 billion euros still to fill, prompting it to hire Citigroup and UBS to advise on strategic options, according to a source familiar with the matter.

With capital shortfalls largely concentrated in banks in Italy, Greece and Cyprus the results were reassuring for investors in bank shares and junior bonds, which might have been at risk of losses if the failures had been bigger and more widespread.

"It makes me more confident about buying sub-ordinate bank debt and bank equity. It removes uncertainty around the banking system capitalization and encourages investors to buy equity and lower-rated debt," said Louis Gargour, chief investment officer at LNG Capital.

Germany's Deutsche Bank (>> Deutsche Bank AG) was one of the big winners, passing the stress tests even before this year's capital raising of 8.5 billion euros was taken into account.

Britian's Lloyds Banking Group (>> Lloyds Banking Group PLC), meanwhile, could be in for a drop on Monday after it only narrowly passed the tests, putting a question mark over its ability to re-start dividends.

GETTING UNDER THE SKIN

The ECB was under pressure to do a thorough purge of banks' balance sheets after previous regional stress tests failed to spot problems, giving Ireland's banks the thumbs up months before they keeled over.

Investors praised the ECB for unveiling some skeletons, including identifying an extra 136 billion euros in non-performing loans, but said the tests still lacked the credibility of similar examinations in the United States because of the political sensitivities of dealing with individual countries and because the ECB is still getting to grips with its new status as a banking supervisor.

"The US regulators have much more of a handle on the true position of the institutions they regulate day-to-day. They have people on the ground within the institutions themselves. The ECB doesn’t actually take up its euro zone regulatory role until Nov. 4," said Barney Reynolds, global head of financial institutions advisory practice at Shearman & Sterling.

"I don’t think it’s regarded as an entirely apolitical exercise internationally but on the other hand it’s the first time a transnational body has, in a credible way, got under the skin of some of these figures."

The ECB tests are seen as crucial to restoring confidence in the region's banks in the wake of the 2007-09 financial crisis and reviving the flow of credit to the euro zone economy.

But investors said Europe needed several years of credible stress tests if they really wanted investors to pour money back into banks in peripheral countries such as Ireland, Spain and Italy.

"This is a step in the right direction, but this is sort of like a baby step. We need to see a couple of years of good test results for those countries and those banks before we even think about it," said Joe Urciuoli, head of credit research at Spectrum Asset Management.

(Additional reporting by Clare Hutchison, Nishant Kumar and Carolyn Cohn in London and Carmel Crimmins in Dublin.)

By Simon Jessop and Sudip Kar-Gupta