By Ryan Tracy, Eyk Henning and Emily Glazer
Large European banks including Deutsche Bank AG and Banco
Santander SA are likely to fail the U.S. Federal Reserve's stress
test over shortcomings in how they measure and predict potential
losses and risks, according to people familiar with the matter.
The expected rebuke would mark the second year large foreign
banks, which were drawn into the Fed's stress test regime in 2014,
failed to meet the U.S. regulator's expectations for risk
management. As banks have bulked up their capital cushions to
ensure they can withstand losses in periods of turmoil, the Fed has
increasingly focused on more "qualitative" issues in its stress
tests, including whether banks accurately measure potential losses
in credit portfolios, collect risk exposure data accurately and
have strong internal controls.
Failing the stress tests would likely subject the U.S. units of
Deutsche Bank and Banco Santander to restrictions on paying
dividends to their European parent companies or other shareholders.
Santander is already under such a restriction after failing its
first stress test run last year. Deutsche Bank is undergoing the
U.S. stress test process for the first time this year.
Both Deutsche Bank and Santander passed European Central Bank
stress tests in October. Those tests focused on whether the banks
had enough capital to withstand a two-year recession but didn't
assess such things as governance, risk management, and other more
subjective factors like the Fed's test.
The Fed's Board of Governors in Washington will disclose partial
results of the test on March 5 and full results on March 11,
including any capital restrictions. Last year, the board met just
ahead of releasing the results to vote on whether banks should fail
the tests for "qualitative" reasons. It ultimately rejected
Citigroup Inc. as well as U.S. units of Santander, HSBC PLC and RBS
PLC on such grounds. It cited the foreign banks for "significant
deficiencies" in their capital planning process. It hasn't
disclosed such a board meeting yet this year. The Fed declined to
comment on specific banks.
Deutsche Bank Trust Corp. is expected to be found adequately
capitalized by the Fed but will likely receive a warning on
qualitative shortcomings, according to people familiar with the
matter.
"Deutsche Bank Trust Corporation, which represents less than 5%
of Deutsche Bank AG's total assets, was pleased to participate" in
the stress tests this year, a spokeswoman said, adding the bank
"will know our results after the Federal Reserve's
announcements."
Deutsche Bank is currently in a remediation process with the Fed
over flaws in areas ranging from its regulatory reporting, risk
control, monitoring and compliance systems, these people added. The
bank has also been reprimanded by the Fed for flaws in its
regulatory reporting, The Wall Street Journal reported last year.
In a letter to Deutsche Bank executives in December, a senior
official with the Federal Reserve Bank of New York said reports
produced by some of the bank's U.S. arms "are of low quality,
inaccurate and unreliable. The size and breadth of errors strongly
suggest that the firm's entire U.S. regulatory reporting structure
requires wide-ranging remedial action."
At the time of the report, a Deutsche Bank spokesman said the
German bank has "been working diligently to further strengthen our
systems and controls and are committed to being best in class" and
said the bank is spending EUR1 billion ($1.35 billion) globally and
appointing 1,300 people, including about 500 compliance, risk and
technology employees in the U.S.
A person familiar with the matter said Santander is also likely
to fail for qualitative reasons, rather than because the stress
test depleted its capital below regulatory minimums.
A Santander spokesman declined to comment on Friday.
Santander has been working to fix the issues since receiving a
rebuke on its stress test last year, but suffered a setback in
September when the Fed said the bank had paid an unauthorized
dividend, violating restrictions placed on the firm after its
failure on the 2014 stress test in March of that year.
The Fed forced Santander's parent company to reimburse the U.S.
unit for the dividend, barred it from additional dividend payouts
and required it to beef up internal controls. At the time,
Santander declined to comment. Ana Patricia BotÃn, the Spanish
firm's new executive chairman, has vowed to improve the banks'
regulatory compliance.
The expected Fed action comes amid a continuing tussle between
the U.S. regulator and foreign banks over what the Fed views as
potential vulnerabilities at overseas firms with large U.S.
operations. The Fed wants European banks to adhere to stricter
rules and fix flaws that could potentially destabilize a firm to
the point it needs support from the American central bank, as
happened during the 2008 financial crisis.
Last year it adopted a rule forcing Deutsche Bank, Santander,
and other foreign banks operating in the U.S. to form U.S.-based
holding companies that adhere to strict risk-management standards
and add potentially billions of dollars more in capital to meet
minimum capital requirements at the U.S. units.
The so-called qualitative part of the stress test has become
increasingly important since the Fed started doing the tests after
the 2008 financial crisis. While the central part of the test
measures whether a bank has enough capital to keep lending during a
deep recession, the "qualitative" aspect of the test includes more
subjective factors such as how the bank manages the stress-test
process and incorporates past lessons and concerns. It also takes
into account how a bank handles costly litigation and manages its
technology systems.
For banks, managing the stress test process is costly. A person
at one bank subject to the test said the firm has invested upward
of $50 million on personnel and systems in the last year alone in
an effort to improve the quality of its data gathering and computer
models, among other stress test-related expenses.
"You don't fundamentally understand the level of effort required
until you are in the program," this person said.
-Jeannette Neumann contributed to this article.
Write to Ryan Tracy at ryan.tracy@wsj.com, Eyk Henning at
eyk.henning@wsj.com and Emily Glazer at emily.glazer@wsj.com
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