European equities steadied on Tuesday, underpinned by some positive earnings reports and stronger energy stocks, after suffering heavy losses in the previous session on persistent concerns over the health of the region's top banks.
The pan-European FTSEurofirst 300, which slumped 3.4 per cent on Monday, was up 0.3 per cent by 0931 GMT after falling earlier in the day. The European banking index also gained 0.4 per cent after sinking 5.6 per cent a day earlier.
Although the market was helped by a rise in energy stocks on stronger oil and gains in firms like Vestas that rose 7 per cent after beating earnings forecasts, sentiment remained fragile. The FTSEurofirst 300 index moved in and out of negative territory several times in the first hour of trading.
Analysts said that the banking sector was prone to further weakness in the near term. The cost of insuring bank debt against default climbed on Monday to its highest since late 2013. Borrowing costs in Spain, Portugal and Italy jumped as investors demanded a fatter risk premium over safer German paper, where two-year yields hit record lows.
"The CDS (credit default swap) market is indicating a future financial stress for bond holders in the banking sector. There are concerns that the banking sector is under-capitalised in Europe and credit conditions are sub-optimal," Lorne Baring, managing director of B Capital Wealth Management, said.
"And when combined that with the global macro backdrop, with Chinese growth slowing down, there is a natural impact of it around the world and the banking sector is bearing the brunt. There could be a wave of defaults in the energy sector and that will damage the balance sheet of the banking sector."
The sell-off in European financial stocks on Monday rippled across the globe as US and Asian stock markets fell sharply, with investors piling into safe-haven assets such as Japanese government bonds. Ten-year JGB yields turned negative for the first time.
Goldman Sachs analysts said that while there were no signs of any strain in terms of euro or US dollar funding in money markets for European banks, market liquidity had nevertheless reduced.
Deutsche Bank shares rose 2 per cent after the German bank had said late on Monday it had "sufficient" reserves to make due payments this year on AT1 securities. Its shares had slumped 9.5 per cent on Monday on concerns about its ability to maintain bond payments.
Investors will pay attention to the testimony of US Federal Reserve Chair Janet Yellen before the House Financial Services Committee on Wednesday, seeking any clue to the strength of the US economy that might underpin the dollar by keeping alive hopes that the central bank may continue on its rate-hiking path.