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Objections mean more CCAR headaches, costs for Santander, Deutsche

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Objections mean more CCAR headaches, costs for Santander, Deutsche

After again failing the CCAR process, Deutsche Bank Trust Corp. and Santander Holdings USA Inc. face more costs and more headachesas they try to right the qualitative issues that continue to sink their annual capitalplans.

Federal Reserve regulators last week announced that for the secondyear in a row they would not approvethe capital plans submitted by both Santander and Deutsche, again citing qualitativeshortcomings because of "broad and substantial weaknesses across their capitalplanning processes, and insufficient progress these firms have made toward correctingthose weaknesses."

Given the firms' previous difficulties and the onerous natureof the CCAR process, there seemed to be an expectation among many industry observersthat federal regulators might again ding the companies on their internal processes.

"I don't think we were surprised that they had these qualitativeobjections — they've had challenges in the past," Christopher Wolfe, a managingdirector with Fitch Ratings, said in an interview.

And though the regulators do not disclose the specific issuesto which they objected, qualitative objections are generally related to auditing,model validation and other internal-control processes, according to Joe Breeden,the founder and CEO of Prescient Models, which consults on analytics and modeling.

He observed that both firms carried some of the highest capitallevels in the CCAR process and said the banks may have anticipated that regulatorswould find ongoing issues with their internal processes — an expectation the highercapital is meant to offset.

"The Fed looks at that and says, 'We'll accept your numbers— they always accept higher numbers — but we will ding you on the fact that youhad to do it in the first place,'" Breeden said, adding that regulators frownon internal processes that rely on capital "overlays."

"That's part and parcel of what regulators look for in theCCAR: Not only when you run the numbers do they show that you have adequate capital,but how did you get there? It's the whole control framework," Wolfe said.

At Deutsche, some of those internal problems have been on displaybefore. In 2014, in a letter from the Federal Reserve Bank of New York to Deutschewhich later became public, bank examiners excoriated the bank's internal and regulatoryreporting. "We have concluded that the regulatory reports provided by [DeutscheBank] are of low quality, inaccurate and unreliable," the New York Fed wrote,adding that the bank's "entire U.S. regulatory reporting structure requireswide-ranging remedial action." It included a long list of issues requiringattention, and the results of 2016's CCAR suggest the bank has yet to complete thatoverhaul in an acceptable fashion.

The problems at Santander are less clear, though Wolfe notedthat the legacy Sovereign Bank was regulated by the now-defunct Office of ThriftSupervision. The change in regulators, as well as the bank's growing consumer financebusiness, which comes with a heavy compliance focus, probably contributes to thechallenges Santander faces.

Another factor likely contributing to the high capitallevels at both banks is that profits get locked up at the U.S. firms; the most immediateconsequence of the objections for the banks is that their international parent firmscannot take capital out of those U.S. subsidiaries, Federal Reserve officials familiarwith the CCAR process said.

"The behavioral pattern is that banks start to pool in resourcesand try to buy their way out … in this case they will still have to spend a lotof money because they are still not at a point where the process is acceptable,"Breeden said. Because the banks have now repeatedly received objections, Breedensaid correcting the issues and restoring credibility with the regulators takes oneven more urgency. As a result, management focus on the issue — and costs — is onlygoing to grow.

"My guess is that there's a lot of consultants lining upat the door right now," Breeden added.