Fed Stress Tests Clear 31 of 33 Big U.S. Banks to Boost Returns to Investors; Deutsche, Santander Flunk

All but two of 33 institutions passed the final round of the Federal Reserve's annual "stress tests," conducted to gauge how such firms would fare in a new financial crisis. (See this interactive graphic on how each bank fared.)

Big firms such as Bank of America Corp. and Citigroup Inc., which struggled on the tests in recent years, passed this time. Morgan Stanley also passed but received a bit of a rebuke. The Fed said it found "weaknesses" in internal risk- management processes and required the bank to submit a revised capital plan by the end of the year, though it will still be able to return capital in the meantime.

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The U.S. banking units of two foreign firms, Deutsche Bank AG and Banco Santander SA, were flunked, due to Fed concerns about their ability to measure risks. It was the second year in a row the German bank failed and the third consecutive failure for the Spanish firm.

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For Deutsche Bank and Santander, the Fed's rejection of those firms' capital plans is a public embarrassment, but the practical impact is more limited. The rejection effectively locks up some U.S. profits, which can't be sent home to the parent firms at a higher rate until they pass the tests, but the firms don't have publicly announced plans to return capital home that would be affected by that restriction, a Fed official said.

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M&T Bank Corp. gained the Fed's approval, but the Buffalo, N.Y., firm passed only after scaling back its proposal to distribute funds to shareholders, to ensure its capital buffers stayed above the minimums required by the Fed.

It was the only bank to take the "mulligan" allowing banks to adjust their payout plans. Had the bank not done so, it would have failed the test by falling below two of the four required capital ratios in a hypothetical recession, the Fed said.