Why the Fed failed two of Europe's biggest banks

Janet Yellen

The U.S. operations of Germany's and Spain's largest banks had their knuckles rapped by the U.S. Federal Reserve late Wednesday.

The Fed failed Deutsche Bank and Santander in key tests of their ability to withstand a future financial crisis. But what exactly have they done wrong? After all, they are two of Europe's most prestigious and largest banks which passed the European Central Bank's October stress tests comfortably.

To start with, the Fed is anxious about having to support the U.S. operations of non-U.S. banks in the event of a future economic crisis, so it is subjecting them to tough scrutiny.

While both banks were judged to have enough capital to pass the Fed's minimum capital requirements, "widespread and substantial weaknesses across their capital planning processes" were identified by the central bank. Essentially, the banks have not failed in terms of their capital position, but in the quality of their analysis of risk. Some investors argue that this is not much to worry about.

This is the second year in a row Santander has failed the tests, while Deutsche's U.S. unit failed them the first year it took them. However, It was the first time all of the U.S. domestic banks passed the stress tests since they began in 2009.

"The European banks have only failed at the margins," Dennis Gartman, the influential investor and author of the "Gartman Letter", who dismissed the tests as "borderline silly", told CNBC Thursday.

"I'm not that concerned, nor do I think anyone else should be. In the case of the stress tests, we know when they will be administered and what questions they have to answer - the fact that anyone will have failed is beyond belief."

Until the U.S. divisions of Deutsche Bank and Santander come up with new capital plans, the Fed has them from raising dividends or making stock buybacks. This is not likely to derail any plans for shareholder rewards this year - Deutsche Bank said it didn't request any dividend payments anyway, and Santander has permission to keep a dividend payout announced earlier this year.

Both banks conceded that they had work to do in the light of the stress tests.

"Deutsche Bank is committed to strengthening and enhancing its capital-planning process," the German bank said in a statement.

"The qualitative assessment highlights that we still have meaningful work to do to meet our regulator's expectations and our own standards of excellence," Scott Powell, chief executive of Santander Holdings USA, said in a statement Wednesday.

- By CNBC's Catherine Boyle

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