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Bank stress tests 1st step in shoring up financial sector, ECB's Draghi says

The mistakes made by Europe's banks – and the damage they caused to the euro zone economy – must never be repeated, Mario Dragi, President of European Central Bank (ECB) told CNBC on Wednesday.

He said the latest round of stress tests for banks were "just a beginning" in ensuring the financial sector was on a stronger footing and would not jeopardize government finances again.

"What's been done in the past must not be repeated again…Things have improved in the banking industry but no, this is not a final point. It's just a beginning of a new way of doing things," he said in an interview with CNBC.

"I insist that the primary objective of this exercise is transparency."

His comments came after the ECB unveiled Wednesday the tough criteria for its stress tests of the euro zone's banks, designed to analyze lenders' ability to withstand adverse economic conditions.

The region's 128 most important banks will undergo an assessment of their risky assets, the quality of their balance sheets, and the amount of capital they hold.

Europe's banks have been at the heart of the euro zone's financial crisis, after taking on too much debt which turned toxic when borrowers struggled with their repayments. A number of European governments were forced to step in and rescue their struggling institutions – deemed in many cases "too big to fail" – which in turn hit the solvency of these already debt-laden countries.

As such, Draghi said that restoring the health of Europe's banks was critical to Europe's "fragile" recovery.

"Let me say that the recovery is still in it's infancy. It's gradually progressing but it's still weak, uneven, and fragile," he said.

"Banks are crucial in this part of the world and they are the main source of credit for small and medium sized firms. That's why it's so important that we make everything that is needed for them to function well."

The central bank chief also said he was confident that national safety nets – or backstops – were in place to plug any gaps exposed by the stress tests.

"Let me reassure you about the backstops," he said. "The transparency, the strength of the design of this exercise, the coverage of this exercise should by itself make the leaders reassured that taxpayers money, if needed - and we all hope it's not going to be needed - is going to be properly used."

To take the burden of rescuing banks off the shoulders of governments, European leaders agreed to create a system that would move supervision of the financial sector to a European level, and the bank stress tests are seen as an important step towards this "banking union".

The ECB said it would conclude its review of the banks in October next year, before taking over as the region's banking watchdog -- under the "Single Supervisory Mechanism" – in November 2014.

Europe's banking union will also feature a common deposit insurance scheme to protect individual savings, and the creation of a single authority with the power to wind down struggling euro zone banks -- although this is being opposed by Germany.

The U.K.'s Prime Minister David Cameron has also expressed skepticism over some aspects of a pan-Eurpean banking union ahead of a referendum on membership of the European Union in 2017, but Draghi said he was convinced that Britain should remain a member of the 28-member union.

"I'm absolutely convinced that the U.K. should stay in the Union, not only for its size and might of the financial sector, but for its history for what the U.K. is for Europe," he said. "And as I had a chance to say in a speech in London, we need a more British Europe and more European Britain."

Reporting by CNBC's Geoff Cutmore.

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