FRANKFURT, July 30 (Reuters) - Deutsche Bank showed a weaker reading in the European Union's banking stress test than most of its peers, indicating that the lender still has far to go in a revamp it launched last year.
In a theoretical economic and financial shock, the capital level of Germany's flagship lender would drop to 7.8 percent from 10.8 percent at the end of last year, ranking it tenth from the bottom in the health check of 51 lenders, data from the European Banking Authority (EBA) showed on Friday.
The test covered 70 percent of EU banking assets and mimicked a three-year financial and economic shock, with new elements such as potential fines and settlements added this time around.
Deutsche Bank scraped past the level of 7.5 percent that analysts had seen as a threshold because of its designation by regulators as one the world's systemically most-important banks.
"We come out of the 2016 stress test stronger than in 2014, although this year's exercise was more demanding," Chief Executive John Cryan said in a statement, adding that the bank would focus on further strengthening its capital.
Financial analyst David Hendler from U.S.-based Viola Risk Advisors said that the stress test showed that Deutsche Bank needs a tremendous amount of capital. "It's beyond their ability to generate it themselves," he said.
Barclays analysts worried ahead of the results that the findings could further sour investors' view of the lender.
"The immediate risk around the stress test is that the capital market's perception of the group - a distressed equity and credit valuation - is enough to warrant some form of intervention," Barclays wrote in a note to clients earlier this week.
Unlike the 2014 exercise, this year's stress test did not have pass or fail marks. Its outcome will, however, be taken into account when the ECB's banking supervisors see how much overall capital each bank should hold, dubbed the SREP ratio.
On top of core requirements - called "Pillar 1" - that are mandatory for all lenders, banks need to hold individual capital cushions to cover additional risks. These additional buffers - "Pillar 2" - consist of a mandatory as well as a recommended part.
"We do not expect material changes to the overall SREP level, but a different composition of Pillar 2," Deutsche Bank Chief Financial Officer Marcus Schenck said earlier this week, adding that he expects regulators will demand banks to pay out less in bonuses and dividends.
Deutsche Bank has so far ruled out another cap hike and expects that it can add up to 7 billion euros to its capital buffers by the end of 2019 to comply with bank rules.
While it does not rule out a loss for 2016, the lender expects to be able to generate a profit of up to 5 billion euros in normal years, with annual cost savings of 1.5 billion being offset by 1 billion euros in litigation charges and 500 million in restructuring costs.
Adding 2.5 billion euros in capital to its reserves annually is realistic, top Deutsche Bank officials have said.
But analysts argue that the gap will become harder to fill as economic conditions deteriorate.
Deutsche Bank CFO Schenck said earlier this week that if high legal bills will limit the bank's capability of building capital organically, it will shed risky assets quicker.
"If there's more pressure coming from the litigation side, as in higher cost, then we need to manage RWA (risk-weighted assets) further down. We do have the contingency plans in place to cope with those situations," he said.
Deutsche Bank has boosted its capital by almost 22 billion euros since the financial crisis and it now holds about four times as much capital against a risky asset than it did 10 years ago.
But Deutsche Bank's current market capitalisation stands at less than 17 billion euros, following a slide in investor confidence and a drop in the share price by nearly half since the start of the year.
Investors and analysts continue to criticise the lender for its thin buffers against potential crisis, albeit usually in a less aggressive tone than a U.S. regulator, which in 2013 called the bank "horribly undercapitalized".
Deutsche Bank's second quarter capital ratio of 10.8 percent compared with 11.9 percent at JP Morgan, 12.2 percent at Goldman Sachs and 12.5 percent at Citi.
Editing by Bernard Orr