Europe's stress tests fail to ease investors' bank sector worries

* Latest tests give banks broad clean bill of health

* Questions raised over failure to assess range of risks

* Bad loans and weak profitability weigh on valuations

By Huw Jones

LONDON, Aug 1 (Reuters) - The latest health check of leading European Union banks failed to end worries about profitability in the sector and the omission of risks such as the effect of negative interest rates and Brexit blunted its impact.

The European Banking Authority (EBA) published the outcome of its health check of 51 lenders from across the EU on Friday evening after markets closed, giving the industry a broadly healthy prognosis.

There were some surprises, for example two major Irish lenders and Barclays (LSE: BARC.L - news) doing less well than expected, while German duo Deutsche Bank (LSE: 0H7D.L - news) and Commerzbank (LSE: 21170377.L - news) fared better than anticipated. But broadly the results showed that banks have come a long way since 2014 in building up their capital buffers.

Analysts said this year's test, the third in the EU and the first one without a pass or fail mark, was "no panacea". They said major elements were missing, including the impact of negative interest rates on banks' ability to make a profit or a mention of Britain's vote to leave the EU.

"Overall, the result of the test was rather reassuring in my view but the real issues of the sector, especially the low rates, were not tested," said Dirk Becker, chief financials analyst with Allianz Global Investors.

At 1045 GMT, the Stoxx index of European banks was down 1.9 percent at 131 points, close to lows seen during the financial crisis.

The index has fallen 13 percent since Britain's vote to leave the European Union on June 23 darkened the region's economic outlook and added to concerns about banks' ability to make money and deal with bad loans.

"This is just one step in the right direction, it's not the be all and end all, and not too much can be read into these results," said George Karamanos, a banking analyst at KBW.

"We remain underweight in the sector."

BAD LOANS

Some experts flagged that while the tests bring transparency, the problems they have highlighted are still a long way from being addressed.

"We estimate there is still approximately a trillion euros of non-performing loans clogging banks' balance sheets across Europe," said Edward Chan, a banking partner at law firm Linklaters.

Analysts said this year's EU stress test is unlikely to quash investor doubts about banks that have sent book values tumbling to below those of U.S (Other OTC: UBGXF - news) . rivals.

"I would not say it draws a line under the banking crisis," said Gary Greenwood, a banks analyst at Shore Capital.

"But at some point you have to say this is not due to the crisis anymore but to a need to address issues that have not been addressed by management."

Book values will go up on the basis of companies retaining profits, not on the back of a stress test, Greenwood added.

With Italy's Monte dei Paschi (Milan: BMPS.MI - news) seen as the only bank having to raise large amounts of capital, analysts say the stress test results will at least not put further downward pressure on book values in general. Monte dei Paschi shares were up 4.4 percent.

The results will be used by regulators -- the European Central Bank for the 37 euro zone lenders that were tested -- to determine overall capital requirements by year end.

"The main challenge for banks will be to demonstrate that the quality of their data and models is sufficient to reliably identify future risks and that they have sound processes in place to manage these risks," said Burcu Guner, senior director at Moody's Analytics.

(Additional reporting by Sinead Cruise; Editing by Keith Weir)