The Federal Reserve has issued a stinging rebuke to two of Europe’s largest banks – Deutsche Bank and Santander.
U.S. operations of Deutsche, Germany’s largest bank, and Santander, the biggest bank in Spain and a large player in the UK market, were found to have serious deficiencies in capital planning and risk management, according to a senior Federal Reserve official.
The systems by which European banks assess risk have been called into question following the failure of the U.S. subsidiaries of the two major European banks to meet criteria set out in the Federal Reserve’s stress tests.
The subsidiaries of both Deutsche Bank and Banco Santander failed the stress tests for “qualitative” reasons among which were their inability to accurately identify risk and to respond realistically to losses.
The annual Fed ‘stress tests’ aim to ensure banks are capable of functioning during periods of “financial stress”.
Of the 31 banks tested, 28 passed, although the Wall Street Journal reports that some big banks “struggled”. Bank of America did not pass the test and has been asked to resubmit its plans.
It is unsettling that the two banks that failed the stress test are subsidiaries of European banks that comfortably passed the ECB’s stress test in October. As we pointed out at the time, the ECB test was of questionable value as it didn’t even model in a potential deflation scenario – despite early signs of and risks of deflation.
Within a few short months Europe was experiencing deflation, demonstrating a lack of competence and or foresight at the ECB. The health and viability of Europe’s banking sector would not appear to be as sound as the ECB has suggested to investors, depositors and the public.
Equally troubling, is the fact that Deutsche Bank, who have derivatives exposure of over a whopping €54 trillion – almost nine times the GDP of the entire Eurozone – has serious issues with risk management.
Warren Buffett’s “financial weapons of mass destruction” – how are you?
Should Deutsche Bank or any other similarly exposed European bank suffer substantial losses it could trigger a major derivatives and or solvency crisis – and contagion in the financial system. With sovereigns and central banks having already badly damaged their balance sheets – another Lehman style crisis may be one which no nation or multi-national institution could resolve.
The best case scenario would involve bail-outs and bail-ins. The worst case scenario would involve currency devaluations internationally and a consequent destruction of wealth.
An allocation to physical gold outside of the banking system will protect savers and investors in such a scenario.