Deutsche Bank’s US unit failed stress test

Deutsche Bank AG’s U.S. subsidiary failed on Thursday the second part of the U.S. Federal Reserve’s annual stress tests due to “widespread and critical deficiencies” in the bank’s capital planning controls.

The Fed board’s unanimous objection to Deutsche Bank’s U.S. capital plan marks another blow for the German lender, sending its shares down 1 percent after hours. Its financial health globally has been under intense scrutiny after S&P cut its rating and questioned its plan to return to profitability.

The Fed also placed conditions on three banks that passed the test. Goldman Sachs Group Inc  and Morgan Stanley cannot increase their capital distributions and State Street Corp must improve its counterparty risk management and analysis, the Fed said.

Deutsche Bank last week easily cleared the Fed’s easier first hurdle that measures its capital levels against a severe recession, the strictest ever run by the Fed.

Stress tests were introduced in the wake of the 2008 financial crisis and every year America’s central bank, the Federal Reserve, puts the country’s banks, including foreign subsidiaries operating in the country, through their paces.

The Fed measures whether banks are holding sufficient capital to cope with a recession and in the second part of the process it focuses on banks’ “capital plans” such as how much cash they intend to return to shareholders. However this is the first year that the results of the US units of foreign banks have been publicly released.

All of the 35 largest banks subject to the tests passed the first part of the tests last week.

But the Fed found Deutsche Bank’s US arm had “material weaknesses in the firm’s data capabilities and controls supporting its capital planning process, as well as weaknesses in its approaches and assumptions used to forecast revenues and losses under stress”.

The verdict is another blow for the troubled German lender whose financial health has been under the spotlight recently. And it will require the bank to make changes to the way it operates in the US.

The stinging rebuke for Deutsche Bank, Europe’s second-largest lender, came as shareholders continue express serious doubts about the bank’s health. The bank’s shares on Wednesday hit a two-year low in Frankfurt.

Deutsche Bank’s US operations failed stress tests in 2015 and 2016 but this was the first time its local holding company, created in 2016, was subjected to the tests.

DB USA said in response to the results that it was working to improve its operations. The company stressed that the Fed did not find its capital would fall below required levels, but failed the bank for “qualitative reasons.”

“DBUSA continues to make progress across a range of programs and will continue to build on these efforts and to engage constructively with regulators to meet both internal and regulatory expectations,” the bank said in a statement.

Other foreign banks facing the qualitative assessments included Barclays, UBS, Credit Suisse, HSBC and TD Bank. All passed.

Because of their conditional passes, Goldman and Morgan Stanley will see their shareholder payouts capped at levels seen in prior years.

This will let them “build capital over the next year,” the Fed said in a statement.

Given the current robust health of the world’s largest economy, the Fed imposed a harsher testing scenario than it had in recent years, with unemployment shooting up to 10 percent, GDP shrinking and financial conditions worsening.

The first round of stress test results released last week – the quantitative test – found the banking sector generally ready to face a severe global recession. But this week’s qualitative test looked at capital planning, including share buybacks and dividend payments.