By Matt Scuffham
NEW YORK (Reuters) - Deutsche Bank AG (DE:DBKGn) executives expect U.S. regulators to continue to impose restrictions on its Wall Street investment bank even if it passes an annual health check, three sources familiar with the matter said.
Executives hope improvements the bank has made to its risk management and capital planning processes since failing last year's test will enable it to achieve a conditional pass this year, the sources said.
The sources said their optimism is based on conversations with Fed officials over several months. However, the Fed has yet to give a final decision and the bank's fourth failure in five years is still possible, they said.
A Deutsche Bank spokesperson said: "We cannot confirm any of the information as the results are not known to us. We respect the process, and we will respect the Federal Reserve's decision, when made."
The Federal Reserve implemented annual tests of lenders after the 2008 financial crisis to check whether they have sufficient capital to weather a major economic downturn.
Even if the bank passes the stress tests, executives expect the Fed to continue to bar it from making payments to its German parent without the Fed's approval, the sources said. They also anticipate Deutsche will be told to continue improving the systems it uses to monitor its business and risks, the sources said.
The tests this week and next come amid uncertainty over the bank's U.S. operations. Deutsche plans cutbacks to appease investors unhappy about its stock market underperformance. It also faces investigations by the Federal Bureau of Investigation and Department of Justice into possible money-laundering lapses. The bank has said it is cooperating with investigators.
Failing the tests would further damage confidence among clients and investors at a time when Chief Executive Officer Christian Sewing is battling to turn around Germany's biggest lender, whose shares hit a record low this month.
Deutsche flunked the second part of the tests last year. The Fed cited "material weaknesses" in its data capabilities and capital planning process. The bank said in April it had "invested heavily to ensure that the bank meets regulators' demands and has made significant progress."
Fed officials recognize the bank has made improvements to its processes but believe more work needs to be done to bring them up to the required standard, the sources said.
This year's tests are likely to be the last for Deutsche's U.S. business under current Americas head, Tom Patrick, the sources said. Patrick is expected to leave in the coming months as the bank's U.S. restructuring progresses, they said. Patrick declined to comment, bank officials said.
Deutsche plans to dramatically reduce the size of its loss-making U.S. equities business as part of an overhaul of its investment bank. However, it plans to retain a substantial U.S. operation to service German corporate clients.
A key task for Patrick's successor, who will need to be approved by the Fed, will be to rebuild confidence among regulators and ensure it can pass future stress tests unconditionally, the sources said.
The Fed is scheduled to announce on Friday the results of the first part of the tests, which measures banks' capital levels against a severe recession. Deutsche is expected to pass that section comfortably, as it did last year, the sources said.
The second part of the tests, which focuses on banks' capital planning and risk management processes, is due to be announced June 27. It is this part that bank officials hope they will conditionally pass this year, the sources said.
(The story refiles to fix typographical error in quote in paragraph 4)