* U.S. Fed objects to capital plans of RBS, HSBC, Santander
* All three banks say will resubmit plans
* Fed objections around processes, not capital strength
* Timing of Citizens IPO could slip (Recasts)
By Steve Slater
LONDON, March 27 (Reuters) - Royal Bank of Scotland's separation and flotation of its U.S. business Citizenscould be delayed after it was one of three foreign banks whichhad their plans for dealing with a financial crisis rejected bythe U.S. Federal Reserve.
The U.S. central bank started scrutinising foreign banks'emergency plans only this year but its tough verdict on RBS,HSBC and Santander - three of Europe's largestbanks - as well as U.S. giant Citigroup throws down agauntlet to the European Central Bank (ECB) as it readies itsown bank stress tests this year.
It also serves as a warning shot for Deutsche Bank and Barclays as they will have toparticipate in future U.S. stress tests due to their largeoperations there.
RBS, HSBC and Santander said they would resubmit their plansfor how to deal with rising losses under a stressed financialscenario.
"The bottom line is that these banks will have to improveinternal controls," said Joseph Dickerson, analyst at Jefferies.
RBS said it was too early to say if it would delay theflotation of Citizens, which it wants to take place in thesecond half of this year with the sale of between 20 percent and33 percent of the bank.
RBS, 81-percent owned by the British government after abailout during the financial crisis, is under pressure fromlocal regulators to drum up capital. An initial public offering(IPO) to sell part of Citizens, which has been valued at between$9 billion and $15 billion, is a major part of itscapital-raising
Resubmitting plans can take several months. Last year theFed did not approve revised capital plans for U.S. bank BB&TCorp until months after it had objected.
"Because it is hard to ascertain the magnitude of change ininternal controls necessary to please the Fed, we therefore havelimited visibility on how the IPO process of Citizens may beimpacted by the rejection of the capital plan," Dickerson said.
Several banks are also casting an eye on Citizens, includingJapan's Sumitomo Mitsui Financial Group and MitsubishiUFJ Financial Group and Canada's TD Bank,industry sources have said.
RBS has said it is planning for an IPO but was open toapproaches from potential buyers.
The Fed's stance is further evidence of how regulatorsacross the world have intensified scrutiny of multinationalbanks since the crisis, forcing more stringent liquidity andcapital requirements on their local operations rather thanrelying on the banks' home regulator to do so.
This shift to "balkanisation" of rules has increased capitaland funding for banks.
HSBC has been unable to repatriate some of the excesscapital it holds in the United States to its parent group inLondon since selling its U.S. credit card business three yearsago.
Analysts said the prospect of that changing looked slim. "Itwill be harder to argue this case when regulators lock upcapital in subsidiaries," said Arun Melmane, analyst atCanaccord.
NEW TO U.S. TESTS
Lenders in Europe face a range of stress tests this yearwith the ECB and the Bank of England, in conjunction with thepan-EU European Banking Authority, preparing to test theregion's banks in an attempt to draw a line under the crisis.
It will be the ECB's first time to oversee the tests and theFrankfurt-based central bank will be under pressure to provethat it has flushed out any nasty surprises before it takes overas supervisor of the currency bloc's banks in November.
The Bank of England said on Thursday that the risk of asharp rise in interest rates and a big fall in house priceswould be a part of this year's stress tests.
The Fed said the three foreign banks were all new to itsprocess, and HSBC and RBS had "significant deficiencies" intheir planning, including "inadequate governance and weakinternal controls around the processes".
The Fed's objection over Santander's plans for its U.S. armSovereign were more severe, saying it was due to "widespread andsignificant deficiencies" across its capital planning processes,including specific problems in governance, internal controls,risk management and its assumptions and analysis that supportcapital planning.
The U.S. central bank did not object to the level of moneythe banks had set aside to cover potential losses.
Last year, Citizens returned $1.2 billion of capital to itsparent group. RBS said the Fed did not object to such a payoutagain this year.
"We clearly have more work to do to meet the Fed'sstandards, and we're fully committed to doing that," said BruceVan Saun, the chairman and CEO of Citizens who used to befinance director at RBS. (Additional reporting by Sarah White in Madrid. Editing byCarmel Crimmins and David Stamp)
HSBC Holdings (HSBA)