Improving markets helped US banks pass stress test

* Regulators were relieved at improving markets by April

* Capital markets looked more willing to supply banks

* Filling half the gap next week would be good outcome

By Mark Felsenthal

WASHINGTON, May 9 (Reuters) - U.S. bank regulators breathed a huge sigh of relief in early April when improving financial markets looked set to push the nation's 19 largest banks through the gauntlet of tough "stress tests" in reasonably good shape.

In early March, a month after Treasury Secretary Timothy Geithner announced the tests on Feb. 10 to help restore investor confidence in the major banks, the scene was much bleaker: major stock indexes had slumped to 12-year lows on persistent fears about the financial weakness. It looked possible that a major bank might need an emergency government rescue even before the stress test results could be announced.

But since the trough, markets improved steadily with rising share prices and volumes, better liquidity and other signs of stabilization, and regulators gained comfort that capital markets would be willing to fill any holes the stress tests unearthed at banks.

"It looked to us by mid-March, and early April, that this might work," said a senior U.S. regulatory official, who spoke on condition of anonymity because of the sensitivity of the tests.

Stress tests released on Thursday showed the largest banks had a $74.6 billion gap to make up to ensure they could withstand a worst-case scenario regulators set for them. Nine of the 19 banks tested already had the necessary buffer and would not need to raise any more.