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(Adds comment from Citigroup, Fed officials)
By Emily Stephenson and David Henry
WASHINGTON/NEW YORK, March 26 (Reuters) - The FederalReserve on Wednesday rejected Citigroup Inc's plans to buy back$6.4 billion of shares and boost its dividends, citingdeficiencies in the bank's ability to plan for how stressfulsituations would hurt its business.
The decision marks the second time in three years thatCitigroup has failed to win the Fed's approval for plan toreturn money to shareholders, known as the "capital plan," andis a blow for a bank still recovering from the financial crisis. Returning money to investors through buying back shares iscritical for Citigroup's meeting a key target for profitability.
Shares of Citi, the third-largest U.S. bank, fell 4.5percent to $47.90 in after-hours trading.
Citi was one of five banks whose payout plans were rejectedby the Fed on Wednesday. Three were the U.S. units of Europeanbanks. The fifth, Zions Bancorp, was expected becauseit was the only bank last week to fail a model run of asimulated crisis similar to the 2007-09 credit meltdown in thefirst part of the Fed's stress tests.
The Fed said it approved capital plans submitted by theremaining 25 big banks in this year's tests.
Citigroup's chief executive officer, Michael Corbat, saidthe bank is "deeply disappointed" by the Fed's decision and thatthe bank's request for returning additional capital toshareholders was modest.
Last year, the Fed granted Citigroup permission to buy back$1.2 billion worth of shares and said it could continue to pay$120 million a year in dividends, representing a quarterly rateof a penny a share.
This year Citigroup sought to spend more than five times asmuch buying back shares and to lift its quarterly dividend to 5cents a share. The bank earned $13.67 billion last year.
Analysts, on average, had estimated that Citigroup'squarterly dividend would increase to 12 cents per share,according to surveys by Thomson Reuters.
Failing to win regulatory approval for the capital plan is asetback for Corbat, who was charged with improving the bank'srelationship with regulators when he took over as CEO in October2012.
On Wednesday, the Fed said that Citigroup has improved itsrisk management practices in recent years, but the bank cannotdetermine well enough how its revenue and income would be hurtunder stressful scenarios around the world. The bank's internalexamination process does not sufficiently consider how globalcrises could influence its broad number of businesses, the Fedadded.
In 2012, the Fed rejected the plan by Citi's then chiefexecutive, Vikram Pandit, a step that contributed to his ousterin October of that year. In the 2012 test, Citigroup did notprove to the Fed's satisfaction that it could adequately measurerisk in loans to some consumers in Southeast Asia, where creditrating standards are not as well developed as in the UnitedStates, according to a person familiar with the matter.
The Fed said on Wednesday that some of Citigroup'sdeficiencies had been "previously identified by supervisors asrequiring attention" and that "there was not sufficientimprovement."
CONCERNS ABOUT FOREIGN BANKS
The other banks blocked by the Fed on Wednesday in theirplans for higher dividends or share buybacks were the U.S. unitsof HSBC, RBS and Santander, due toweaknesses in their capital planning processes.
Zions, the fifth bank whose plan was barred, was the onlybank out of 30 to miss minimum hurdles for regulatory capital ina first tranche of the stress tests, which simulate a futurecrisis as severe as the 2007-09 credit meltdown.
"Both the firms and supervisors have more work to do as wecontinue to raise expectations for the quality of riskmanagement in the nation's largest banks," Fed Governor DanielTarullo said in a statement on Wednesday.
The five banks will not be allowed to move forward withproposed raises in dividends and share buybacks, though they cancontinue with shareholder payouts at the same pace as they didlast year.
Fed officials told reporters that capital distributions atthe banks had been sufficiently modest in past years that theycould continue at current levels without hurting the firms.
The Fed's criticism of internal controls,risk-identification and other planning elements at the foreignbanks underscores regulators' concerns about the safety of thosefirms' operations in the United States.
Foreign banks will have to wall off their U.S. units andmeet tougher capital requirements under rules recently finalizedby the Fed.
The Fed has said HSBC, RBS and Santander all would likelyfall under those new rules.
Two large Wall Street banks, Bank of America andGoldman Sachs, had to resubmit their capital plans afterseeing their first set of stress test results.
The annual tests aim to determine whether banks are robustenough to weather the next crisis.
For this round, regulators looked at whether banks couldcarry out their planned capital distributions and maintain abuffer. The rejections indicate that officials are not satisfiedwith banks' preparations for a hypothetical future downturn.
The Fed did not disclose the details of banks' proposedcapital plans. Banks whose plans were approved are expected toannounce them soon. (Reporting by David Henry in New York and Emily Stephenson inWashington; Additional reporting by Douwe Miedema in Washington;Editing by Dan Wilchins and Leslie Adler)
