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Deutsche Bank passes Fed stress test in boost for its U.S. operations

Pete Schroeder and Matt Scuffham

WASHINGTON/NEW YORK, June 27 (Reuters) - Deutsche Bank AG on Thursday passed an annual health check by the Federal Reserve, clearing a second hurdle at a critical time for the German lender in tests administered by the U.S. central bank that measure banks' ability to weather a major economic downturn.

However, the Federal Reserve placed conditions on Credit Suisse's U.S. operations after finding weaknesses in its capital planning processes.

The results provide a boost to the Wall Street operations of Deutsche Bank, Germany's largest lender, which have been plagued by litigation, underperformance and regulatory investigations.

The tests assess whether it is safe for banks to implement their capital plans, including using extra capital for stock buybacks, dividends and other purposes beyond being a cushion against losses. They are designed to avoid the taxpayer bailouts prevalent in the 2007-2009 financial crisis.

The Fed's stamp of approval gives Deutsche a major boost as it works on a restructuring plan. Deutsche flunked the test in 2015, 2016 and 2018. Another failure would have further damaged confidence among clients and investors at a time when Chief Executive Christian Sewing is battling to turn around the bank, whose shares hit a record low this month.

The Federal Reserve, meanwhile, ordered Credit Suisse to address weaknesses in its capital adequacy process by October, and restricted its capital distributions to last year's levels until those weaknesses are addressed. The Fed said it had identified "weaknesses in the assumptions used by the firm to project stressed trading losses that raise concerns about the firm's capital adequacy and capital planning process." It gave no further detail.

The Fed approved the capital plans of the 16 other banks that underwent this year's test, which includes the nation's largest lenders like JPMorgan Chase, Bank of America and Citigroup.

The Fed said in a statement that the nation's largest banks all have strong capital levels and "virtually all" are meeting supervisory expectations for capital planning.

The test results also show that JPMorgan and Capital One both had to pare back their capital plans, after initial plans submitted to the Fed showed that each would see capital levels drop below regulatory minimums under a severe economic downturn, according to a senior Fed official.

Deutsche Banks passing grade reflected the significant progress the bank had made in addressing its weaknesses around capital planning, although some issues remain, according to a senior Fed official.

Deutsche's Sewing told investors at the annual shareholders' meeting last month that the bank planned to make "tough cutbacks" at its investment bank to appease investors unhappy with its underperformance. Those plans are likely to see the bank's U.S. equities business shrunk to a skeleton operation, Reuters reported this month.

The stress test outcome means that Deutsche is now free to make payments to its German parent without approval from the Fed, a restriction which was imposed following the stress test failure last year.

Deutsche maintained a large presence on Wall Street after the 2007-2009 financial crisis, while Credit Suisse made big cuts. However, Deutsche's efforts to compete with U.S. rivals have been hampered by litigation and regulatory investigations.

Deutsche is currently facing U.S. government probes into possible money laundering lapses. The bank has said it is cooperating with investigators.

All the 18 banks easily cleared the first portion of the Fed's annual stress test last week, showing they would easily have enough capital to keep lending during a severe economic downturn.

The second test was more rigorous, assessing whether it is safe for banks to implement their capital plans.

Deutsche was the only bank to fail the test last year after the Fed identified "widespread and critical deficiencies" in the bank's capital planning controls. Goldman Sachs, Morgan Stanley and State Street Corp, which received conditional passes last year, passed without conditions this year.

This year's tests are more streamlined following a Fed review of the process. Roughly half as many banks were tested in 2019 compared to 2018, as the Fed moved to a two-year testing cycle for smaller firms.

($1 = 0.8801 euros) (Reporting by Pete Schroeder in Washington and Matthew Scuffham in New York Edited by Neal Templin and Leslie Adler)