One of the world’s largest banks will find out on Thursday if it has failed a crucial regulatory test.
Deutsche Bank, a large, beleaguered German lender with a big presence on Wall Street, may come up short in the Federal Reserve’s annual stress tests because of problems in its United States operations that the Fed has reportedly already highlighted in the course of its regular supervision.
The stress tests, which apply to the largest United States banks and the American operations of big foreign lenders, take place in two legs. The first tests assess whether the banks have sufficient capital to absorb losses that might occur in a deep recession. Deutsche Bank did relatively well in that test last week.
The second portion, whose results come out on Thursday, determines whether the banks’ operations and planning are up to the task of dealing with the turbulence. If a bank fails this second round, the Fed most likely will limit how much it can pay out to shareholders in the form of dividends and stock buybacks. Deutsche Bank’s existing problems may make it hard for the bank to pass this so-called qualitative part of the stress tests.
Deutsche Bank and some other large foreign banks are under particular scrutiny this year because, for the first time, they are publicly releasing stress test results for a much larger portion of their businesses in the United States. Regulators required large foreign banks to consolidate some or most of their American businesses into special entities that are subject to many of the same regulations as big United States banks. The Fed stress-tested those entities for the first time last year, but the results were kept private.
The push to increase regulation of large foreign banks was required after the financial crisis of 2008, when several giant foreign institutions took emergency loans from the Fed. To try to avert the need for such assistance again, Congress required greater regulation of foreign banks’ American operations.
In the past, some foreign banks found it difficult to pass the qualitative part of the stress tests. This year, because the Fed is testing considerably more of the foreign banks’ American operations, the hurdle is even higher.
Failing the test could prompt the Fed to limit the amount of money the foreign banks’ American entities pay to their parent companies. While doing so would strengthen the United States entity, it could be a problem for a bank whose parent company needs the cash.
Failure would add to Deutsche Bank’s woes. Over the past decade, many large global banks that suffered in the crisis have managed to convince investors that they have turned themselves around. But investors still have serious doubts about Deutsche Bank’s revival efforts.
The bank’s stock is down over 40 percent this year alone, and it has changed its chief executive three times in the last seven years. But if Deutsche Bank passes Thursday’s test, its new chief executive, Christian Sewing, will at least be able to say the bank’s vexed relations with the Fed have improved.
