March 6, 2015 / 10:14 AM / in 3 years

Tougher test awaits Deutsche Bank after clearing first Fed check

FRANKFURT (Reuters) - Deutsche Bank DBKGn.DE AG has passed the first “stress test” set by U.S. regulators but is unlikely to clear the next hurdle as the German bank struggles to tighten compliance fast enough to appease controllers at the Federal Reserve.

The headquarters of Deutsche Bank are pictured in Frankfurt January 29, 2015. REUTERS/Ralph Orlowski

Deutsche eased through the capital test of the two-part exam on Thursday, showing its U.S. operations had an ample cash cushion to survive even a severe market downturn.

It even came out as the most robust of all the 31 banks to take the test, due to the fact that the unit tested represented only a small, low-risk part of its sprawling U.S. operations.

But the Fed is widely expected to fail Deutsche Bank in a test of processes and controls on March 11, underscoring how much work lies ahead for Deutsche to expand successfully in the world’s largest market, analysts say.

“It’s almost inevitable that you won’t pass with flying colors, whatever you do,” said Bridget Gandy, managing director at Fitch Ratings. Many first-time test takers, in fact, fail, she said.

“It won’t be because of lack of capital or managing their operations that they fail, but that they haven’t managed their operations in such a way as to tick each box to come through the test well,” she said.

Deutsche said Thursday’s results demonstrated the robustness the unit that was tested, which represents less than 5 percent of its total assets, but declined to comment on the outcome expected next week.

“Like the other banks, we’ll know the results on March 11,” a spokesman said.

PRIMARY SUPERVISION

Other foreign banks have failed the U.S. test the first time round. Banco Santander SAN.MC, Europe’s biggest bank, failed last year, as have HSBC HSBA.L and Royal Bank of Scotland RBS.L.

Deutsche has avoided primary supervision by the Fed up to now by structuring its operations so they came largely under the purview of the Securities and Exchange Commission. Legal changes in 2013 forced the bank under the Fed’s oversight.

By running its Comprehensive Capital Analysis and Review (CCAR) tests, the Fed aims to ensure foreign banks are as well-run as domestic ones, and that the U.S. government is not left on the hook for problems created by overseas-based lenders.

While no punitive actions are expected, a failure would give Deutsche a black eye just as it races to bolster internal reporting and controls. The bank is half way through a four-year plan to invest some 1 billion euros ($1.1 billion) in beefing up compliance.

The bank has hired some 500 staff to address weaknesses in U.S. financial reporting and hired Elizabeth Ford from Goldman Sachs GS.N as head of compliance in the Americas. Deutsche will also bring on board Steven Reich, a U.S. defense lawyer with experience in the White House.

In doing so, Deutsche is playing catch-up with those banks who have already taken the Fed tests for the past four years.

Deutsche aims to fortify its position as a global securities house and is the only global bank with such a strategy that doesn’t have its headquarters on Wall Street.

A failure would highlight an even bigger challenge ahead: Deutsche’s entire U.S. operation is set to be tested in 2018.

The unit examined this time, Deutsche Bank Trust Corp, or DBTC, has a balance sheet worth about $62 billion, making it the smallest part of the bank’s U.S. empire. It houses primarily wealth management and transaction operations.

The rest, most housed in its Deutsche Bank Securities Inc (DBSI) unit, contains the important broker-dealer operations, the core of its investment bank and the heart of its U.S. push.

Deutsche was the target in 2014 of punishing criticisms from U.S. regulators for “low quality, inaccurate and unreliable” financial reports at some of its U.S. divisions, showing the scope of the task ahead to bring those operations up to snuff.

($1 = 0.9114 euros)

Editing by David Holmes

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