It’s the banks, stupid. The European Union cannot fix its sovereign debt problem without a holistic solution that quells investors’ concerns about banks. For as long as they believe that the bloc’s banks are undercapitalised, addicted to European Central Bank funding, and dangerously exposed to weak eurozone sovereign risks, investors will stick to the sidelines. Procrastinating governments in the weakest peripheral economies have helped ensure that sovereign risk concerns crowd out all else in investors’ views of the region’s banks. But, as Portugal teeters, can it really damage Europe’s banks?

Total European bank exposure to Portugal was $216bn last September, according to Bank for International Settlements data. That is less than half their Irish exposure and about 40 per cent more than their Greek risk. However, the total exposure of Europe’s listed banks (excluding Portuguese lenders) to Portugal’s government debt is much lower – about €17bn, Morgan Stanley estimates. The sovereign accounts for a relatively insignificant proportion of any one bank’s total assets. Take Santander. It could easily absorb a haircut on its Portuguese government debt exposure of about €2.4bn: its equity is €75bn. A haircut is probably a lesser concern than the effect of sluggish Portuguese economic growth on its operations there.

So Portugal’s woes are unlikely to derail systemically important European lenders. That does not mean national regulators can stand idly by. Rather, they should look beyond the lame parameters of the impending EU stress tests, and require full disclosure of banks’ sovereign exposure, whether in their banking or trading books, and proof beyond doubt that banks’ capital buffers are strong. Only then will the depressingly close correlation between sovereign risk and the performance of European bank shares of the past six months be broken. US stress tests have been a catalyst for recovery in US bank stocks. EU tests could be, too.