Deutsche and Santander fail US stress test

The Federal Reserve has vetoed the US capital plans of Deutsche Bank and Santander in a stinging rebuke for the European banks even as US lenders got the green light to launch their biggest payouts to shareholders since the financial crisis.

US operations of Deutsche, Germany's largest bank, and Santander, the biggest bank in Spain, were found to have serious deficiencies in capital planning and risk management, according to a senior Fed official.

The official said that any bank with chronic problems in those areas could eventually face a cease-and-desist order, compelling them to make specific changes or pay financial penalties. Santander has now failed the test - known as the Comprehensive Capital Analysis and Review (CCAR) - two years in succession; Deutsche was tested for the first time this year.

Failing the test prevents the US entities of the foreign banks from distributing capital to their parent companies and highlights the tougher attitude from the Fed towards overseas banks, which it worries it might have to support in a crisis.

For the first year since the tests started in 2009, the Fed approved every US bank's capital plan, paving the way for higher dividends and bigger share buybacks. As has become traditional, banks raced to announce billions of dollars of payouts for shareholders after the test results came out.

The CCAR result was a huge relief to Citigroup where the management, including chief executive Mike Corbat, was under threat if the bank had failed the test for a second year in a row. Citi was able to lift its dividend for the first time since 2008, to 5 cents a share from 1 cent, and launch a $7.8bn buyback.

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US banks were not unscathed, however. Bank of America received a "conditional" approval for its capital distribution plans, requiring it to make improvements to its risk-handling procedures by the third quarter or run into trouble with the Fed. Goldman Sachs, JPMorgan Chase and Morgan Stanley all had to adjust their plans to win approval after the Fed found their original plans for capital return would have left them with too thin a shock absorber.

The Fed introduced stress tests in 2009 in what proved to be a turning point in the financial crisis, restoring investors' confidence in the resilience of US banks. They were since adopted as an annual - and more complex and gruelling - test of whether the biggest banks would be able to withstand a severe economic or market shock.

Banks can pass or fail on both quantitative and qualitative grounds. Failing to meet the quantitative capital threshold forces banks to trim or cancel their planned distribution to shareholders. As a result the tests have become one of the most closely watched annual events by bank investors.

"The results gave us a lot of comfort that the basic game plan to get banks exceptionally well capitalised has been playing out nicely," said Doug Burtnick, a Philadelphia-based investment manager at Aberdeen Asset Management.

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