[WASHINGTON] The Federal Reserve said on Wednesday 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. But Santander Holdings USA fell short of the Fed's evaluation for the third year in a row, while Deutsche Bank Trust Corporation failed for the second straight year.
The Fed last week announced that all 33 large financial institutions had cleared the quantitative aspect of the stress test. That meant they were deemed to be holding sufficient capital to withstand a severe economic hit, such as a bad recession.
Federal Reserve 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 European Union last week. The Fed's scenarios include 10 per cent 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.
"We have already begun preparing for next year's stress test and we are well on our way to making the enhancements necessary to improve our qualitative assessment,"said Santander Holdings US chief executive Scott Powell.
Deutsche Bank also said it would work to improve.
"The capital adequacy of Deutsche Bank Trust Corporation has never been in doubt," said Bill Woodley, chief executive of Deutsche Bank USA.
"We appreciate the Federal Reserve's recognition of our progress, and we will implement the lessons learned this year in order to strengthen our capital planning process." 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.
Morgan Stanley said it planned repurchases of up to US$3.5 billion in shares and would boost its dividend to 20 cents per share from 15 cents.
"We are very pleased to be able to increase our capital return to shareholders for the fourth consecutive year. Returning additional capital to our shareholders is a key element of our strategic plan," chief executive James Gorman said.
"In addition, we are committed to addressing the Fed's concerns about our capital planning process and fully expect to meet their requirements within the established timeframe." Several other banks, including Bank of America, Citigroup and JPMorgan Chase, 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.
Banks have amassed US$700 billion in additional capital compared with 2009, to US$1.2 trillion, boosting their common equity capital ratio, which compares high-quality capital to risk-weighted assets.
"Over the six years in which (the stress tests) have been in place, the participating firms have strengthened their capital positions and improved their risk-management capacities," said Fed governor Daniel Tarullo.
"Continued progress in both areas will further enhance the resiliency of the nation's largest banks."
The Fed said it would push for more improvement in some key areas, saying it identified a broad problem throughout the industry in internal audits.
The Fed said it plans a "thorough review" of large banks' internal auditing later in 2016.