The US Federal Reserve on Wednesday said that US operations of Germany’s Deutsche Bank and Spain’s Santander had failed an annual stress test, citing weaknesses in their capital planning and risk management.
The Fed granted a conditional approval to US investment bank Morgan Stanley to return funds to shareholders, while delivering a full endorsement to 30 other large financial institutions on their capital distribution plans.
The central bank’s report pointed to the improved capacity of the US financial system overall to withstand an economic shock.
However, Santander Holdings USA fell short of the Fed’s evaluation for the third year in a row, while Deutsche Bank Trust Corp failed for the second straight year.
The Fed last week said that all 33 large financial institutions had cleared the quantitative aspect of the stress test. That means they were deemed to be holding sufficient capital to withstand a severe economic hit, such as a bad recession.
Fed officials said the types of negative scenarios incorporated into the tests were comparable with the worst-case outcomes some have said could play out after Britain decided to leave the EU last week. The Fed’s scenarios include 10 percent unemployment and negative interest rates for US Treasuries.
The Fed said it had found significant fault in the qualitative aspects of the plans to return capital to shareholders by the US units of Santander and Deutsche Bank, saying they both relied on assumptions that are “not reasonable or appropriate.”
Key problems at the two European banks included poor risk measurement processes, stress testing procedures and data infrastructure. Santander officials said they were pleased the bank had passed the quantitative analysis, but disappointed at falling short otherwise.
Deutsche Bank also said it would work to improve.
The immediate impact of the Fed decision is to block any capital distributions from the two banks.
Morgan Stanley is permitted to conduct capital distributions, but must remediate weaknesses, including in modeling and governance, within six months.
If Morgan Stanley fails to win an endorsement at that time, the Fed could block additional distributions.
Several other banks, including Bank of America, Citigroup Inc and JPMorgan Chase & Co, announced new dividend increases or plans to make stock repurchases following the Fed’s review.
The Fed said the winning of approval by the vast majority of the banks illustrates the benefits of capital building requirements overseen by the Fed since the 2008 financial crisis.
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