Last checked at 
* NY Fed sees shoddy reporting, inadequate auditing
* Says Deutsche Bank made no progress fixing problems
* Bank to come under closer Fed scrutiny from 2016
* Shares down 0.5 percent, underperforming peers (Adds Dudley speech, details on examiners)
By Kathrin Jones and Arno Schuetze
FRANKFURT, July 23 (Reuters) - The Federal Reserve Bank ofNew York has found serious problems in Deutsche Bank AG's U.S. operations, including shoddy financialreporting, weak technology and inadequate auditing andoversight, people close to the matter told Reuters.
In a letter to the German lender's executives last December,a senior official with the New York Fed described financialreports produced by some of the bank's U.S. divisions as "lowquality, inaccurate and unreliable", said one of the sources,who is familiar with the letter.
The New York Fed, as the U.S. central bank's eyes and earson Wall Street, directly supervises the biggest U.S. and foreignbanks, partly through embedded regulators who go to work eachday inside the firms.
"The size and breadth of errors strongly suggest that thefirm's entire U.S. regulatory reporting structure requireswide-ranging remedial action," said the letter, first reportedby the Wall Street Journal. (http://on.wsj.com/1r3VIn3)
The New York Fed declined to comment, citing theconfidentiality of supervisory activities. The European CentralBank and German financial watchdog Bafin declined to comment.
Deutsche said it was investing 1 billion euros ($1.4billion) to upgrade its internal systems, including the qualityof its reporting, with about 1,300 people working on theimprovements. "We have been working diligently to furtherstrengthen our systems and controls," a spokeswoman said.
The letter is nonetheless a blow to Deutsche Bank co-ChiefExecutives Juergen Fitschen and Anshu Jain, who have beenseeking to transform the lender's corporate culture amid scandals, investigations and fines following the financialcrisis of 2008-2009.
While the New York State Department of Financial Services islooking at Deutsche in relation to issues including possibleforex manipulation and Iran sanctions violations, the New YorkFed's concerns are separate and arose from routine examinationsby its staff, a source familiar with the matter said.
Other sources familiar with the matter said technical issueswere at the heart of the reporting problems, meaning Deutschewill likely have to add or amend any documentation it puts out,such as statements on its performance, but not face large fines.
"These type of issues have gone from just plain looking atthe balance sheet to qualitative management issues, and the Fedseems to be very unhappy with these guys," said a sourcefamiliar with the matter.
BEST IN CLASS
Deutsche Bank shares lost 0.5 percent, one of the biggestdecliners in Germany's blue-chip index and the Europeanbanking sector.
"This does not fit with Deutsche Bank's ambitions to be bestin class," said a Deutsche Bank shareholder, who declined to benamed because he did not want to put at risk his relationshipwith the bank.
Germany's largest bank has been in U.S. regulators'crosshairs for some time over a host of issues, includinginvestigations emanating from the financial crisis and criticismthat it is too thinly cushioned against potential losses.
A U.S. Senate committee this week accused Deutsche, alongwith rival Barclays, of helping hedge fund clients toavoid taxes. Deutsche is also under investigation by U.S.authorities over alleged sanctions violations.
With the threat of fines and settlement costs looming, aswell as European banking stress tests year, Germany's largestlender raised 8.5 billion euros last month to strengthen itsbalance sheet.
Deutsche's capital strength had been under the spotlightsince Thomas Hoenig, vice-chairman of the Federal DepositInsurance Corp, a U.S. banking regulator, described the bank as"horribly undercapitalised" in an interview with Reuters lastyear.
The bank, like other foreign lenders, will come under closerscrutiny by the Federal Reserve from 2016 and will be requiredto retain deeper capital cushions to absorb potential losses,while holding easy-to-sell assets to raise cash quickly in apotential crisis.
Foreign lenders will also be included in the Fed's stresstests of banks' resilience to economic shocks.
The Dec. 11 letter from the New York Fed to Deutsche Banksaid the bank had made no progress in fixing previouslyidentified problems and ordered senior bank executives to ensuresteps were taken to fix the problems. It also said the bankmight have to restate some financial data it has submitted toregulators.
A month before the letter was sent to Deutsche, New York FedPresident William Dudley talked of "the apparent lack of respectfor law, regulation and the public trust" in general at largelenders. "There is evidence of deep-seated cultural and ethicalfailures" at many of them, he said in a Nov. 7 speech ontoo-big-to-fail banks.
U.S. regulators ramped up the number of staff embedded atWall Street banks in the wake of the financial crisis, with thebiggest firms housing more than 100 examiners from the Fed andthe Office of the Comptroller of the Currency.
The New York Fed would not say how many embeds are currentlyat Deutsche Bank.
"You'd like to think that the New York Fed is on top of itsgame and sends letters like this all the time to the big boys,but I'm not so sure," said Walker Todd, a former New York Fedlegal officer now at the Institute for New Economic Thinking.
"The field examiners find these sorts of violations all thetime. But comparatively few make it this high up the foodchain."
($1 = 0.7428 Euros)
(Reporting by Kathrin Jones, Arno Schuetze, Aruna Viswanatha,Emily Flitter, Jonathan Spicer and Avik Das; Editing by DavidGoodman, David Holmes and Dan Grebler)
