The European Banking Authority has revealed that the continent's banks have a €70bn capital black hole in their balance sheets.
According to the latest report by the EBA, which is charged with the task of assessing European financial institution capital health, banks are currently not fully compliant with new capital requirement regulations coming into force in 2019.
However in the latest update, the EBA estimated that by the end of 2012, the 42 banks' capital shortfall had been cut by €29.1bn (£24.5bn, $39.3bn), compared with the previous six months.
According to new Basel III rules that are being rolled out across the world in six years time, banks must hold more reserve capital, worth 7% of their assets, in order to withstand potential economic shocks and therefore prevent future government bailouts.
All banks must also reduce the number of risky assets it holds on their balance sheets by January 2019.
In December 2012, European leaders agreed on a single supervisory mechanism that will empower the European Central Bank with the responsibility for regulating EU banks.
This was seen as an initial step towards a banking union which would eventually make the single currency more centralised and unified.
As the European sovereign debt crisis exploded in 2010, the flaws in monetary union have been exposed.
However, European policymakers have still not found a decisive solution to fix Europe's dysfunctional monetary union and break the link between risky banks and indebted European governments.
Some top ECB officials have expressed deep concern over the EBA's findings.
Yves Mersch, a member of the ECB's executive board, said that national governments might have to act as backstop if future stress tests reveal that EU banks cannot raise enough cash in time of new regulations.
In a speech given at an Austrian banking conference, Mensch warned that cleaning up banks was a priority as 80% of corporate financing in Europe comes from the financial sector.
Yet, he also said that another public backstop might be needed if cash strapped governments could not plug gaps identified in banks' balance sheets.
"When both options - private sector and national budgets - are exhausted, a further form of safety net must be used."
However, Mersch did not provide an alternative solution to the capital shortfall funding, if European governments were unable to bail out the banks.
"It has to be assessed on a case-by-case basis to what extent a temporary access to a public backstop is needed to ensure a quick and smooth recapitalization without excessive use of taxpayer money or a negative impact on financial stability," said Mersch.
Furthermore, Mersch made it clear that the ECB could not start the review of bank balance sheets until a solid backstop was in place.