The latest stress test results turned out to be continued embarrassments for Deutsche Bank AG (DB Quick QuoteDB - Free Report) and Banco Santander, S.A. (SAN Quick QuoteSAN - Free Report) as the Federal Reserve objected to the capital plans of their U.S. units once again.

While both the U.S. units of these European banks – Deutsche Bank Trust Corporation and Santander Holdings USA, Inc. – remain well capitalized, the capital plans were rejected based on qualitative concerns under the U.S. Fed's Comprehensive Capital Analysis and Review (CCAR) 2016.

Notably, for Santander Holdings this year marked the third straight year of failing the Fed stress tests while it's the second consecutive year for Deutsche Bank’s U.S. wing.

Concerns

The Fed noted that the capital plans of the two banks were rejected due to “broad and substantial weaknesses across their capital planning processes, and insufficient progress these firms have made toward correcting those weaknesses and meeting supervisory expectations.”

For Deutsche Bank Trust, the Fed identified shortcomings in the risk management and control infrastructure that limits the reliability of the capital planning process of the company. On similar concerns, the Fed stated that capital planning processes at Santander depicted deficiencies in the risk management framework, including key features of the risk measurement and monitoring function.

Precisely, the Fed found that both the banks’ assumptions and analysis underlying the capital plans are “not reasonable or appropriate.” However, on a positive note, the Fed acknowledged that Deutsche Bank Trust showed improvements in certain features of capital planning while Santander made progress in enhancing some approaches to loss and revenue projection.

The rejection of the capital plan prohibits these banks to distribute capital to their parent companies. However, they may choose to resubmit their capital plans to the Fed after substantial progress in the resolution of the issues.

Response

Chief Executive Officer (CEO) of Deutsche Bank USA, Bill Woodley, stated, “The capital adequacy of Deutsche Bank Trust Corporation has never been in doubt".  Woodley added "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 for future CCAR submissions.”

Scott Powell, Santander Holdings USA CEO said "We are well on our way to making the enhancements necessary to improve our qualitative assessment.”

Bottom Line

The periodic tests evaluate the financial stability of the large banks under hypothetical stressful situations. These banks come under the U.S. Fed’s CCAR, which is conducted in compliance with the stress test rules of the Dodd-Frank Act. Assessing the health of the financial institutions since 2009, stress tests have been one of the important measures to prevent any further financial crisis.

Apart from assessing the adequate capital levels, qualitative check is of equal importance in the stress test as it examines banks' controls and procedures in risk management, technology, stress test management and the appropriate measures taken by the banks in business practices following the crisis. The CCAR process determines whether the banks have enough capital strength to support its capital actions like dividend payments and share buybacks.

Overall thirty financial institutions including Citigroup Inc. (C Quick QuoteC - Free Report) and Bank of America Corp. (BAC Quick QuoteBAC - Free Report) received Fed’s no objection on their capital plans, however, Morgan Stanley was issued a conditional non-objection and is required to resubmit its plan by the end of 2016.

Deutsche Bank currently carries a Zacks Rank #5 (Strong Sell) while Banco Santander carries a Zacks Rank #3 (Hold).

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