ECB Allowed Deutsche Bank To Cheat In Latest Stress Test, FT Reports

In the latest scandal to emerge involving Deutsche Bank, earlier today the FT reported that German's largest lender was allowed to cheat, pardon was given "special treatment" by the ECB in the July stress tests.  As part of the July stress tests results, which "promised to restore faith in Europe’s banks by assessing all of their finances in the same way" Deutsche Bank’s result was boosted by a "special concession" agreed to by Mario Draghi: DB's results included the $4 billion in proceeds from selling its stake in Chinese lender Hua Xia even though the deal had not been done by the end of 2015, the official cut-off point for transactions to be included.

While the Hua Xia sale was agreed in December 2015, it has still not been completed and now faces a delay after missing a regulatory deadline last month, though the bank is still confident of completion this year.

As the FT notes, the Hua Xia treatment was disclosed in a footnote to Deutsche’s stress test results, and adds that "none of the other 50 banks in the stress tests had similar footnotes, even though several also had deals agreed but not completed at the end of 2015."

As disclosed in the central bank's summer stress test, Deutsche’s common equity tier one capital fell to 7.8% after it was "subjected to the stress tests’ imagined doomsday scenario of fines, low interest rates and low economic growth." However, without the Hua Xia boost, the ratio would have been 7.4%, a level comfortably above regulatory minimums. Why the speal treatment? Because the higher published result helped reassure investors who were growing increasingly nervy about the bank’s capital adequacy.

Other banks were not as lucky:

In one case, Spanish lender Caixabank completed the €2.65bn sale of foreign assets to its parent company Criteria Holding in March but was still not allowed to include the impact of that sale in its results.

The special treatment raised eyebrows among market analysts: “This [Deutsche’s treatment] is perplexing,” said Chris Wheeler, an analyst at Atlantic Equities. “The circumstances mean that it is inevitable the market watchers will be suspicious and have some concern about the veracity of the results.”

Nicolas Véron of Bruegel, the Brussels think-tank, said it was important that both the ECB and the European Banking Authority, which oversaw the tests, could “explain and defend their methodological choices”, especially given the market focus on Deutsche. “Stress testing methodologies should be applied uniformly and without any special treatment,” he added. “This of course equally applies to banks that are systemically important, such as Deutsche Bank.”

The only comment the ECB gave to the FT is that the central bank “treats all banks equally in line with the regulation” even though that appeared not to be the case in an attempt to pad DB's balance sheet. The ECB would not comment on the Deutsche case specifically. The EBA said that there were more than 20 “one-offs” approved in the stress tests. “The one-offs are designed to avoid obvious anomalies in the forward-looking stress test where events have already taken place in 2015,” the EBA said.

According to the FT, other “one-offs” were disclosed citing a clause in the methodology that permits limited concessions around “administrative expenses, profit or loss from discontinued operations and other operation expenses”. Still, there is an obvious contradiction between the disclosure and the stated rules:

The Deutsche disclosure simply says that the results include the proceeds of the Hua Xia sale, which “will be closed in 2016”. There is no effort to reconcile that to the official rules, which say: “any divestments, capital measures or other transactions that were not completed before 31 December 2015, even if they were agreed upon before this date, should not be taken into account in the projections”.

As a result of the report, DB shares, which earlier had traded as low as -3% on the day following the weekend report that the German lender's negotiations with the DOJ had dailed to reach a deal, rebounded and were almost unchanged on the day as traders read into the report that the ECB would break even its own rules to keep Deutsche Bank stable.