Term Paper - Risk Management in Financial Institutions

This project provides a comprehensive analysis of CitiBank's risk management strategies and performance compared to its industry peers over a 5-year period.

INTRODUCTION

CitiBank, N. A. (N. A. stands for "National Association") is the primary U.S. banking subsidiary of financial services multinational Citigroup. CitiBank was founded in 1812 as the City Bank of New York and later became the First National City Bank of New York. The bank has 2,649 branches in 19 countries, including 723 branches in the United States and 1,494 branches in Mexico operated by its subsidiary Banamex. The U.S. branches are concentrated in six metropolitan areas: New York, Chicago, Los Angeles, San Francisco, Washington, D.C., and Miami. CitiBank is the 3rd largest bank in the United States by assets.

This document is primarily devoted to conducting a comprehensive assessment of CitiBank's overall performance in the context of its recent historical events. This assessment is embedded in a broader analytical framework that includes a study of the significant risks faced by the institution, along with a comparative assessment of two well-known analogs, namely Bank of America and JP Morgan Bank.

The scope of this analysis covers the period from 2019 to 2023, with all empirical data obtained from the website of the Federal Deposit Insurance Corporation (FDIC), in particular, taking into account data for the first quarter of each year.

INTEREST RATE RISK

Ⅰ. Repricing GAP

Interest rate risk is a critical consideration for financial intermediaries, arising when the maturities of their assets do not align with the maturities of their liabilities. The Federal Reserve has been raising interest rates since the beginning of March 2022. Since then, interest rates have increased 11 times to around 5.4%. To assess the extent of CitiBank's exposure to interest rate risk relative to its counterparts, Bank of America and JP Morgan, it is imperative to delve into the concept of "GAPs" and their comparative evaluation. The GAP is the differential between the monetary value of all assets affected by fluctuations in interest rates within a specific timeframe (referred to as rate-sensitive assets or RSAs) and the monetary value of all liabilities similarly impacted by interest rate changes during that same period (termed rate-sensitive liabilities or RSLs). In mathematical terms, GAP calculation can be expressed as follows: GAP= RSA-RSL.

ANALYSIS:

CitiBank has the largest repricing GAPs within shorter-term maturity buckets (less than 1 year) compared to its GAPs in longer-term buckets. The large magnitude of short-term repricing GAPs seems to reflect a strategy that CitiBank has in place. Given that interest rates have been rising in the short term, CitiBank can increase their net interest margins, which is the difference between their interest income and their interest expenses. This proportion that CitiBank has differs from the rest of the industry as CitiBank has much lower repricing GAPs for the maturity bucket of 3+ years compared to its peer group of JP Morgan and Bank of America. Thus, compared to JP Morgan and Bank of America, CitiBank will have lower interest rate risk for its longer-term maturity buckets. This could be attributed to CitiBank’s reliance on holding more long-term maturity liabilities than long-term maturity assets, and also to a similar strategy to its peer group of maintaining a standard ratio between lower maturity assets and liabilities.

Notably, the trends across the 5-year duration are somewhat different across maturity buckets, as CitiBank has been consistent in increasing repricing GAPs for maturity buckets of < 1 year and 3+ years between 2019 and 2022. On the other hand, its peers have displayed volatility for those maturity buckets over the same period. For these two maturity buckets, both CitiBank and its peer group displayed a significant decrease in repricing GAPs in 2023. This may be due to the banks’ desires to mitigate their interest rate risk since it is uncertain whether or not the Federal Reserve will continue to raise rates. Additionally, CitiBank shows growth in repricing GAPs for the 1-3 years maturity bucket, with a slight stagnation in 2021. The bank’s peers grew their repricing GAPs steadily from 2019 to 2022, instead, exhibiting a downturn in 2023. With the increase in repricing GAPs for these 1-3 year maturity buckets over the 5-year period, CitiBank is exposing itself to higher interest rate risk. If interest rates decrease in 1-3 years, as it is expected to do so in 2024-2025, then CitiBank can face losses as the interest rates of the liabilities that they had in the past will cost the company more than the income it receives from its newly acquired assets.

Ⅱ. Interest Income/ Non-Interest Income ratio:

In addition to examining GAPs, our analysis includes an assessment of the ^{Interest Income}⁄_{Non-Interest Income} ratio. It serves as one of the main indicators for assessing an institution's exposure to interest rate fluctuations.

A higher interest income indicates a bank's greater exposure to interest rate risks because it implies a greater dependence on interest rate-sensitive assets. On the other hand, a lower ratio value indicates a more favorable position of the bank as it implies less dependence on interest income, which reduces the bank's vulnerability to interest rate fluctuations. Thus, the ratio is an important parameter in the comparative assessment of CitiBank, Bank of America, and JP Morgan, as it helps to assess the risk exposure of one or another bank.

ANALYSIS:

As observed from the graph, throughout the five years, CitiBank's ratio of interest income to non-interest income is consistently higher than that of other financial institutions. This suggests that CitiBank relies more on interest income, which makes it more sensitive to interest rate fluctuations, and therefore its interest rate risk is higher than that of other banks. In addition, it should be noted that both CitiBank and the other banks share a common pattern: their ratios decrease between 2019 and 2021 and then increase between 2021 and 2023. The decline in the ratio of interest and non-interest income in the initial period can be attributed to the negative impact of the COVID-19 pandemic and the accompanying environment of low-interest rates to sustain the economy. Subsequently, the ratio increased as the economy began to recover, and with it, interest rates began to rise again.

CREDIT RISK

Credit risk is one of the key concerns for financial institutions as it relates to the potential for loan and security cash flows to not be fully paid. This risk is prevalent across various FIs, particularly those engaged in long-term lending and bond acquisition such as banks, thrifts, and life insurance companies. In the event of borrower default, both the principal amount and interest payments are jeopardized.

To effectively manage credit risk, banks must undertake the classification of borrowers to differentiate between those who are likely to repay their obligations and those who may default. In this section, our primary objective is to evaluate how successful our bank was at avoiding the non-payers compared with other banks.

Credit risk analysis is important for FI managers because it determines several features of a loan: interest rate, maturity, collateral, and other covenants. Riskier projects require more analysis before loans are approved. If credit risk analysis is inadequate, default rates could be higher and push a bank into insolvency, especially if the markets are competitive and the margins are low.

Ⅰ. Loan Portfolio Composition (Consumer, C&I, Real Estate, Other)

The tables below show how the observed banks emphasized on the importance of the type of customer they lend to. The table below shows the segmentation of the different loan types from 2019-2023 for CitiBank and its peer group average. There is a clear trend for CitiBank, which holds even proportions of loans for individuals, C&I loans, real estate loans, and other loans and leases. These relatively stable ratios of loan type within its portfolio indicate a high level of diversification for the FI’s credit risk. This strategy is consistent with the peer group, which exhibits slightly higher volatility in the proportions between the 4 aforementioned loan types. Farm loans hold an insignificant weight for both CitiBank and the peer groups across the period since the banks are located in big cities where agriculture is not popular.

It is also essential to note that individual consumer loans have historically experienced high rates of default, typically ranging from 4-8%. Furthermore, defaults on real estate loans are known to have played a significant role in the recent financial crisis, exemplified by the 2007-2008 events. Consequently, these two loan types are considered the most risky.

Upon examining CitiBank and the average peer group, it becomes evident that CitiBank places greater reliance on individual loans, whereas the peer average group leans more heavily towards real estate loans. Therefore, both CitiBank and the peer average group find themselves exposed to risks. While CitiBank faces less exposure to real estate loan risks, it is more vulnerable to default risks due to the higher proportion of individual loans in its portfolio.

Ⅱ. Net Charge Offs/Total Loan

Net-charge off represents how many loans the bank accepts that will not be repaid. The ratio that we are investigating is a performance indicator: it shows how many loans are classified as actual losses. If our ratio increases, then the risk of default increases.

The chart above illustrates a notable similarity between CitiBank and the average of its peer group, as both exhibit a declining trend in ratios from 2020 to 2022, followed by an increase from 2022 to 2023. This pattern could be explained by an improvement in economic conditions by 2022, subsequently deteriorating in 2023. Moreover, it is evident that CitiBank consistently maintains higher ratios compared to its peer group average, which suggests a possibility of less efficient credit risk evaluation by CitiBank. Alternatively, this difference may happen due to a more conservative approach adopted by peer group banks in recognizing potential loans.

Ⅲ. Long-Term Assets/Total Assets

Since Long-term loans are more likely to default, this ratio shows how likely a bank is exposed to credit risk. The higher the ratio, the higher our Credit Risk.

Based on the provided graph, it becomes evident that CitiBank exhibits a lower ratio compared to the average of its peer group throughout the span of five years. This observation leads to the inference that CitiBank adopts a strategic approach that minimizes its reliance on long-term assets. Such a strategy serves to diversify their credit risk, as longer-term assets tend to possess greater inherent risk compared to shorter-term assets (higher maturity leads to higher risk).

Ⅳ. Loan Loss Allowance/Total Loans

The allowance for loan and lease losses is a valuation allowance against total loans held for investment and lease financing receivables. It represents an amount considered to be appropriate to cover estimated credit losses in the current loan portfolio and its purpose is to absorb net charge-offs likely to be realized.

The higher the ratio, the better for the health of the banks.

The graph illustrates that CitiBank consistently maintains a higher ratio compared to its peer group throughout the specified period. This suggests that CitiBank exhibits greater resilience against losses. It is also possible that this higher ratio is a result of CitiBank's comparatively higher NCOs, necessitating a larger allocation for potential losses. For the period between 2019-2020 and 2021-2023, ^NCOs⁄_{Total Loans} ratios and ^{Loan Loss Allowance}⁄_{Total Loans} have the same trend, showing that the higher the NCO, the higher the Loan Loss Allowance. In 2021 CitiBank had the highest ^{Loan Loss Allowance}⁄_{Total Loans} ratio, indicating that the bank was expecting that losses would be high in that year.

Ⅴ. Loans for Sale/Total Loans

This ratio indicates the proportion of loans that are specifically granted for sales purposes compared to the overall loan portfolio.

Selling assets leads to a process named securitization. Securitization is a process whereby financial institutions sell their assets and consolidate them into interest-bearing securities. This enables them to offload unwanted assets and acquire capital, which can be used to finance additional loans. According to the provided graph, there are contrasting trends between CitiBank and its peer group from 2019-2021. However, both entities experienced a declining trend in securitization from 2022-2023, indicating a reduced reliance on this practice. This can be seen as a positive sign. Notably, CitiBank undergoes a significant increase in its securitization ratio from 2021-2022. This may be attributed to less efficient operations in previous years, and the decision to sell assets potentially could have helped address this issue.

Ⅵ. Earnings Coverage of NCOs

It is net operating income before taxes, securities gains or losses, and extraor­dinary items, plus the provision for possible loan and lease-financing receivable losses divided by net loan and lease losses.

According to the depicted graph, there is a consistently higher ratio for the peer group throughout the entire period, indicating that the risk associated with the peer group is comparatively lower. This is attributed to their superior earnings, which provide them with the capability to offset potential losses. In contrast, CitiBank's ratio remained relatively stable from 2019 to 2021 but witnessed a significant increase in 2022. This notable rise could be attributed to the bank's anticipation of greater losses in comparison to previous years, potentially as a result of deteriorating economic conditions.

SOVEREIGN RISK

Sovereign risk is defined as the uncertainty associated with the likelihood that the host government may not make foreign exchange available to the borrowing firm to fulfill its payment obligations. Thus, even though the borrowing firm has the resources to repay, it may not be able to do so because of actions beyond its control. Thus, creditors need to account for sovereign risk in their decision process when choosing to invest abroad. Analyzing the proportion of foreign assets, liabilities, and net interest income reflects the exposure an FI has to unanticipated global events, and therefore, its level of sovereign risk.

Ⅰ. Top 5 Country Exposures (Lending, Trading/Investing, Other)

In the table above, we can see the top 5 country exposure for CitiBank in 2022. It is important to notice that these are all highly developed countries with relatively low economic risk. CitiBank is known for being the leading global bank with a high presence abroad, which explains its reliance on foreign investments, especially in comparison to its peers. This strength of CitiBank can also be a challenge, as it must be risk-averse in its positioning on political, environmental, and social activities abroad. Therefore, the FI is significantly more sensitive to sovereign risk, as foreign event shocks have much greater consequences for CitiBank than its peers due to its considerable level of global exposure.

Ⅱ. Foreign Deposits/Total Deposits

The charts below exemplify the drastic differences in foreign activity for CitiBank compared to its peer group. Its foreign deposits make up 40-50% of total deposits, whereas the peer group holds 10-13% of its average deposits abroad. This reflects a heightened exposure for CitiBank regarding the negative economic impacts of foreign events or the volatility of various exchange rates. Though the percentage of foreign deposits has trended downward in the observed period, it is currently more than 4x higher than the peer group average, which is significant to note. Perhaps in future years, this trend of decreasing ratio will continue, further hedging CitiBank against sovereign risk.

Ⅲ. Foreign Loans/Total Loans

The charts below reflect CitiBank’s reliance on foreign loans as a percentage of its total loans, with about 30-40% of its loans from 2019-2023 being held abroad. Notably, 2023 reflects a drop in foreign loans compared to the years prior, perhaps due to increased conflict abroad and further awareness of the ESG risks of global investments. On the other hand, its peer group has held about 10-11% of total loans in foreign offices, a much smaller proportion compared to CitiBank. This shows that CitiBank has a lot more exposure to sovereign risk, which can be a disadvantage when its peers have contained this by focusing on loans domestically.

Ⅳ. Foreign Interest Income/Total Interest Income

In comparison to the previous 2 charts, CitiBank is more aligned with its peer group in terms of the relative proportions of foreign interest income to total interest income. In the observed period, CitiBank has trended downward with this ratio holding around 16-22%, whereas the peer group shows a bit more volatility and a range of 9-15%. These percentages are much more similar amongst the FIs, showing stability from CitiBank and market alignment, as both groups reflect a significant downturn from 2022 to 2023.

LIQUIDITY RISK

Liquidity risk is the potential losses that can occur from the inability to meet short-term payment obligations. Banks have to monitor this concentration of risk as the consequence of not having sufficient liquidity can lead to significant losses from selling assets at a lesser value and in rare cases, insolvency. CitiBank manages its liquidity risks through a standardized global risk governance framework that introduces policies, methodologies, controls, and procedures. Their strategy allows them to have a manageable risk appetite to ensure that they do not surpass their enforced liquidity tolerance levels. This approach may change in the near future since interest rates are dropping and Citigroup would have to re-evaluate its liquidity risk limits and triggers to adapt to the current market conditions and regulatory requirements.

Ⅰ. Liquid Assets/Total Deposits

Citi’s strategy to ensure that the bank is liquid during any periods of stress is proven through the percentage of liquid assets that they have in comparison to their total deposits. In recent years, CitiBank has outperformed its competitors in terms of this specific ratio. From 2019-2021 they have shown a steady increase in this percentage, however, they experienced a downward trend in 2022 which they recovered from the following year. Many competitors did not seem to prioritize this liquidity ratio until after the COVID-19 pandemic as they experienced drastic increases after 2020.

Ⅱ. Total Loans/Total Deposits

The total loans over total deposits ratio determines how much a bank borrows to fund its day-to-day operational activities. Citi’s approach has been nearly identical to its peers when determining what is the maximum proportion of loans they can take out in relation to their deposits. Prior to 2021, Citi along with the two banks we compared it to (J.P. Morgan & Bank of America) had about ³⁄₅ the amount of total deposits as loans. After 2020, the bank has been declining that percentage to mitigate liquidity risks.

Ⅲ. Fed Fund Purchased/Fed Fund Sold

The Fed Fund Purchased over Fed fund sold ratio reveals how much a bank borrows from federal funds in comparison to how much they lend. CitiBank borrows from the Fed at a relatively low rate in comparison to its peers. This ratio reveals that they may be missing out on interest rate income that the other banks are currently taking advantage of due to the spread in interest rates from the loans that they receive to the rate that they pay their depositors. However, this approach that Citigroup is taking is much safer and reduces their liquidity risk as they do not have to borrow much to meet their financial obligations.

Ⅳ. Loan Commitments/Total Assets

The loan commitments over the total assets ratio reveal the percentage of loans that have not been claimed by borrowers yet in comparison to the total assets of the lender. A financial institution that has a large ^{load commitment}⁄_{total asset} ratio, is susceptible to more risk as it may need to liquidate its assets to meet its loan obligations. On the other hand, there are banks such as Citigroup, J.P. Morgan, and Bank of America that aim to keep this ratio under 1%. A low ratio indicates that the financial institution is not exposed to unexpected loan requests (which aligns with Citi’s risk management strategy).

MARKET RISK

“Market risk is the risk of loss on a position that could result from movements in market prices. Citi's market risk arises principally from trading and market-making activities by ICG's equity markets and fixed income markets businesses within Global Markets” (Citigroup).

Ⅰ. VaR (Interest Rates, FX, Equities, Commodities, Credit)

Value at Risk (VaR) is a common measure for assessing an FI’s market risk, as it indicates the maximum potential loss from an adverse event at a given point in time and confidence level. There are interesting changes from 2021 to 2022 for CitiBank’s VaR, reflecting differing economic conditions globally and various exposures to market risk. As seen in the tables below, CitiBank encountered a significant increase in Interest Rate VaR, which already had the highest dollar amount in 2021, as well as an upturn in Credit VaR, which could both be attributed to changing dynamics with its credit and sovereign risk approaches. In the same period, Foreign Exchange VaR and Equities VaR experienced a downturn, reflecting how market risk greatly varies based on what lens an FI is observed through. In comparison to its peer FIs, CitiBank’s Interest Rate VaR was especially high in 2022, and compared to the other variables, the interest rate was CitiBank’s greatest VaR value by a significant margin. However, it is important to note that the banks report VaR at different levels (i.e. BofA at 99% level and JPM at 95% level), which influences the comparison between this peer group.

Ⅱ. Trading Assets/Total Assets

The trading assets to total assets ratio is useful in further analyzing market risk. CitiBank is somewhat consistent with this percentage in relation to its peer group average, all ranging around 7-10% in the 5 years observed. This suggests that these large FIs face similar amounts of market risk, with volatility in the years around the pandemic, as CitiBank had a higher ratio in 2020 and slightly lower in 2021 compared to its peer group. The overall consistency amongst the FIs reflects a similar strategy to maintain a stable percentage of trading assets to total assets. This helps to eliminate any level of market risk that would be unique to one FI.

Ⅲ. Trading Account Gains & Fees/Net Income

The trading account gains & fees over net income ratio determine the proportion of net income that comes from their trading activities. Citi has maintained a rate between 20-40% in the past 5 years which indicates that they are exposed to market risk at a relatively high rate and potential losses can occur if the financial markets underperform. However, Citigroup’s strategy to have the most optimal risk appetite, helped the bank remain afloat in times of uncertainty. As seen in the first quarter of 2020, the peer average had a negative rate due to J.P. Morgan facing $940MM in trading account losses. These losses were a result of the COVID-19 pandemic which had a significant impact on the market. Citigroup’s trading account gains & fees over net income ratio saw a decline after 2022, which indicates that they are working on making the financial institution less susceptible to market risk.

CAPITAL ADEQUACY RISK

Capital adequacy risk is the probability of a bank being unable to meet its financial obligations due to unexpected losses from its assets. Citigroup’s strategy to maintain an appropriate level of risk appetite connects with this concentration as they have to determine the optimal percentage of risk-weighted assets to store. Having too few risky assets would limit their profitability while having too much can cause them to be exposed to severe losses. This balance can be determined by calculating the following ratios: ^{tier 1}⁄_{risk-weighted assets}, ^{total capital}⁄_{risk-weighted assets}, and ^{risk-weighted assets}⁄_{total assets}.

Ⅰ. Tier 1/Risk-Weighted Assets

The Tier 1 core capital (equity and reserves) over risk-weighted assets ratio measures a bank’s ability to handle potential losses given its financial strength. This ratio has been adopted by Basel III to build a risk management framework for banks throughout the world. CitiBank and its peers’ ^{Tier 1}⁄_RWA ratio has been gradually increasing throughout the past 5 years which indicates that they are working on becoming less vulnerable during times of financial stress. CitiBank approaching the 15% mark reveals that the bank has great financial health and can meet their obligations even with economic shocks.

Ⅱ. Total Capital/Risk-Weighted Assets

Total capital over risk-weighted assets is practically the same as the previous ratio except, both Tier 1 and Tier 2 capital (supplementary capital) are added together to obtain the bank’s entire capital. This proportion is another capital adequacy ratio that determines how much capital a bank has in comparison to the losses it can possibly face from its current assets. Basel III requires all banks to have a capital adequacy ratio greater than 10.5% to mitigate risks. Based on the data, Citi and their peers have been working on increasing this ratio for both financial and regulatory reasons. Citigroup is committed to maintaining financial stability and ensuring that they have capital stored for the future.

Ⅲ. Risk-Weighted Assets/Total Assets

Risk-weighted assets over total assets signify the percentage of risky assets that a bank has. Unlike the last two ratios, the greater the percentage of this ratio, the more susceptible the bank is to risks. In the past 5 years, Citigroup has always maintained a lower percentage than its peers and has stayed around the 60% range since 2020. This range could possibly be the most optimal proportion for the company where they can potentially have significant returns on their investments while also reducing their insolvency chances of becoming insolvent.

OFF-BALANCE SHEET RISK

CitiBank, like any other FI, faces off-balance sheet (OBS) risk due to financial obligations and instruments that have significant impacts on the firm’s stability and performance, but that are not recorded on the balance sheet. These items include derivatives, contingent liabilities, and unused commitments, and the risks posed undergo significant changes over time based on evolving global market conditions and shifts in regulatory environments at all points of operations. CitiBank manages OBS risk by maintaining sufficient liquidity and maximizing its OBS asset management strategies.

Ⅰ. Derivatives/Total Assets

The ratio between derivatives held to total assets held indicates a bank’s strategy for managing its quantities of derivatives compared to other OBS assets, as derivatives are the most important and influential source of OBS risk for almost all FIs. It is significant to note that the size of a bank’s balance sheet corresponds with its quantity of derivatives held, which is especially pertinent for an FI of CitiBank’s size and global presence. A higher ^derivates⁄_{total assets} ratio reflects a higher exposure to OBS risk, and as seen above, CitiBank faces a much higher level of OBS risk than the peer average. CitiBank has a consistently higher ratio across the 5-year observed period in comparison to its peer group, yet the trends year-to-year somewhat mirror the peer average. Across 2019 to 2023, CitiBank held at least 5-10 times more derivatives by value than total assets compared to the peer average, with the smallest difference in 2020 most likely attributable to the COVID-19 pandemic (27x the value of derivatives to total assets for CitiBank and 22x the value of derivatives. Additionally, 2019 to 2020 reflected the greatest downturn in the amount of derivatives held compared to total assets, also likely due to the economic turmoil that the pandemic caused. However, there was a significant uptick in CitiBank’s ratio from 2022 to 2023 (27x the value of derivatives to total assets up to 33x the value of derivatives to total assets) which could reflect a boost in confidence that mirrors pre-pandemic levels, in comparison to the peer average, which essentially flatlined at 20x derivatives held compared to total assets.

Ⅱ. Off-Balance Sheet Assets/Total Assets

The ratio between OBS assets held to total assets held indicates a bank’s position in managing its OBS risk over time, as it directly reflects the level of exposure an FI may have over changes in the values of its OBS assets. In comparing this graph to the prior one, it is clear that derivatives make up the majority of CitiBank and its peer average’s OBS assets, as there is little difference in the ratios of derivatives to total assets compared to OBS assets to total assets. Therefore, many of the aforementioned points apply regarding trends across the observed 5-year period, reflecting CitiBank’s high exposure to OBS risk compared to the peer average. On average from 2019-2023, CitiBank held about 140% more OBS assets than total assets compared to the peer average, reflecting a business strategy that utilizes a high quantity of derivatives to add value and increase returns while mitigating the associated risks through specific OBS asset management strategies and maintaining sufficient liquidity in the event of economic shocks. This reliance on derivatives seems to be working for CitiBank in the long term, as the higher level of risk leads to higher returns when properly diversified.

OPERATIONAL RISK

At Citi, operational risk entails the risk of losses arising from internal process or system inadequacies or failures, which can be due to human error, mismanagement, or misjudgment, or from external events or factors. This category of risk includes legal risk, including losses that result from non-compliance with laws, regulations, ethical standards, and contractual obligations, but excludes strategic and reputational risks. While acknowledging operational risk’s impact on its reputation, Citi has created a comprehensive risk taxonomy that supports its Operational Risk Management Framework and is aligned with regulatory requirements, such as U.S. Basel III, Comprehensive Capital Analysis and Review (CCAR), Heightened Standards for Large Financial Institutions, and Dodd-Frank Act Stress Testing (DFAST).

Citi maintains a strong operational risk approach to mitigate the potential for financial losses to the highest extent possible, relative to business characteristics, market dynamics, capital, liquidity, and the environments in which it encompasses and encounters. The goal of this framework is to effectively manage operational risk exposures and reduce them within Citi’s risk appetite.

Citi has established its global Operational Risk Management Framework through its Independent Operational Risk Management group to outline policies and practices for identifying, measuring, monitoring, managing, and reporting various operational risks. The framework includes an operational risk appetite definition, a manager’s control assessment process to self-identify significant risks, and other requirements for Citi’s operating segments. These segments must follow this framework and maintain compliance with Citi’s defined operational risk appetite by understanding, designing controls, establishing key indicators, monitoring, reporting, and periodically estimating and aggregating operational risks. This ensures sufficient resources for Citi’s ongoing improvement in managing its operational risk exposures.

Furthermore, Citi must consider operational risks that arise due to product introductions or adaptations, as well as those related to organizational shifts. Governance structures are segmented into Business Risk and Controls Committees (BRCCs), including Citigroup’s Global BRCC, and various subcommittees based on the specific business line, function, and region or country of operation. BRCCs oversee operational risk exposures and create escalation channels for senior management’s review. These committee members are senior business and functions leaders and their second line of defense, who collectively monitor key indicators, control issues, and operational risk events and appetite breaches. Additionally, Independent Risk Management collaborates with Citi’s businesses and functions to foster robust frameworks for operational risk management. Within this team, the Operational Risk Management group actively challenges the quality and implementation of these frameworks and their requirements.

Each major business segment reports key operational risks, historical losses, and their respective control environments, and senior management and Audit and Risk Committees receive summarized reports of Citi’s operational risk profile. As an addendum, Citi measures operational risk through Operational Risk Capital and Regulatory Capital under Basel III Advanced Approaches. Projected operational risk losses during stress scenarios are estimated as part of the FRB's CCAR process (Citi). Citi's approach to operational risk management remains dynamic and emphasizes adaptability and compliance with evolving regulatory expectations.

PROFITABILITY

“New York, October 13, 2023 – Citigroup Inc. today reported net income for the third quarter 2023 of $3.5 billion, or $1.63 per diluted share, on revenues of $20.1 billion. This compares to net income of $3.5 billion, or $1.63 per diluted share, on revenues of $18.5 billion for the third quarter 2022”. It shows a brilliant performance for sure, but – as we will see in this section – not too different from its direct competitors, overall compared in terms of efficiency. To determine CitiBank’s profitability in comparison to the peer average, we are going to analyze its ROA, ROE, NIM, Leverage, and Efficiency Ratios over the past five years (2019-2023).

Ⅰ. Return on Assets (ROA)

The return on assets (ROA) is a financial ratio that indicates how profitable a company is in relation to its total assets. Analysts and investors can use ROA to determine how efficiently a company uses its assets to generate a profit. It can be calculated by dividing a company’s net income by its total assets. A higher ROA means a company is more efficient and productive at managing its balance sheet to generate profits while a lower ROA indicates there is room for improvement. As can be seen from the graph presented, a parallel can be drawn between the trend of the peer average and CitiBank. Notably, both exhibit a downward trajectory from 2019 to 2020, followed by an upward trend from 2020 to 2021. They then experience subsequent downturns and recoveries. It could be explained by the appearance of a Covid19. In 2020, since there was an economic downturn worldwide, bank ratios decreased. In 2021, thanks to the implemented policies, such as lower interest rates, that helped boost the economy, banks were able to get a profit from the loans, which increased their ROA.

From 2019 to 2023, it is observed that the average peer is consistently outperforming CitiBank, indicating that other financial institutions have been more adept at generating net incomes on their assets. The exception, however, is 2021 when CitiBank achieves superiority in this metric. We can decompose 𝑅𝑂𝐴 = ^{Net Income}⁄_{Total Assets}, and notice that while the Total Assets remained constant over the years, Net Income has approximately the same trend as ROA. Net income of $7.9 billion in 2021 increased significantly from 2020 due to the lower cost of credit. Therefore, a sufficient increase in Net Income leads to a substantial increase in ROA.

Ⅱ. Return on Equity (ROE)

Return on equity (ROE) is the measure of a company's net income divided by its shareholders' equity. ROE is a gauge of a corporation's profitability and how efficiently it generates those profits. The higher the ROE, the better a company is at converting its equity financing into profits. Sometimes an extremely high ROE is a good thing if net income is extremely large compared to equity because a company’s performance is so strong. However, an extremely high ROE is often due to a small equity account compared to net income, which indicates risk. We can notice from the graph that the trend for ratios is the same as for the ROA. It is happening since both ratios are used to determine how efficient a company is at generating profits. The main differentiator between the two is that ROA takes into account ^leverage⁄_debt, while ROE does not. Therefore, the only difference from the previous ratio is that the numbers that we are investigating now are higher.

For further proof, we decomposed 𝑅𝑂𝐴 as Net Income over Shareholders' Equity and noticed that while the Shareholders’ Equity remained constant over the years, Net Income is the only component that is changing, and following the same trend as ROA and ROE.

Ⅲ. Net Interest Margin

Net interest margin (NIM) is a measurement comparing the net interest income a financial firm generates from credit products like loans and mortgages, with the outgoing interest it pays holders of savings accounts and certificates of deposit (CDs). This metric helps prospective investors determine whether or not to invest in a given financial services firm by providing visibility into the profitability of their interest income versus their interest expenses. In other words, a positive net interest margin suggests that an entity operates profitably, while a negative figure implies investment inefficiency. In our graph above, we can see that during the observed 5-year period, CitiBank's NIM ratio is higher than the peer average. It tells us that CitiBank generates more income than expenses. Also, ratios for both peer average and CitiBank are higher than 0, meaning that banks operate profitably. Furthermore, it is evident that both ratios have a decreasing trend from 2019-2021 and increasing from 2021-2023. In 2021 they both had the lowest NIM during the observed period. It can be explained by the fact that during 2021 because of the fear of COVID-19 and its consequences, loans became less desirable, thus making savings a more attractive option, which consequently decreased net interest margins. In 2022, the interest rate was decreased to promote economic growth after the pandemic. Therefore, consumers were more likely to borrow money and less likely to save it. It leads to an increased NIM ratio.

Ⅳ. Leverage (Core Capital) Ratio

A leverage ratio is any one of several financial measurements that look at how much capital comes in the form of debt (loans) or assesses the ability of a company to meet its financial obligations. The leverage ratio category is important because companies rely on a mixture of equity and debt to finance their operations, and knowing the amount of debt held by a company is useful in evaluating whether it can pay off its debts as they come due. High Leverage means significant reliance on external debt financing sources, while Low Leverage - operations are funded mostly with internally generated cash. The ratio can be calculated as Total equity over Total Assets. If this ratio decreases, it could be driving the increase in ROE (since the denominator decreases), but in our case even though there is a decrease in 2021 for the leverage ratio, the increase in ROE was mostly due to Net Income, not to changes in Shareholders Equity.

From the graph, we can see that the leverage (core capital) ratio is almost the same for both peer average and CitiBank, but the latter is still higher. Both ratios are following the same trend: they are slightly decreasing from 2019-2022 and then slightly increasing in 2023. It means that while there was COVID-19, banks tried to minimize their reliance on debts, as they might be afraid of being unable to pay off them.

Ⅴ. Efficiency Ratio

An efficiency ratio is a measure of how a company utilizes its resources to make a profit. The ratio is calculated as non-interest expenses divided by revenue. This shows how well the bank's managers control their overhead (or "back office") expenses. This allows analysts to assess the performance of commercial and investment banks. Since a bank's operating expenses are in the numerator and its revenue is in the denominator, a lower efficiency ratio means that a bank is operating better. An efficiency ratio of 50% or under is considered optimal. If the efficiency ratio increases, it means a bank's expenses are increasing or its revenues are decreasing. As can be observed from the graph, both CitiBank and Peer Average experience the same trend: increasing till 2022, decreasing after. It could be explained by the fact that during the economic downturn, due to the Covid-19 pandemic, expenses were increased and revenues were decreased because of unforeseen circumstances. Therefore, our ratios were higher than 50% during that time, and in 2023 when the economy started to recover ratios decreased and became around 50% percent.

Moreover, CitiBank mostly has a lower ratio, thus indicating the lack of efficiency of the peer average group and the higher cost of getting revenue.

In conclusion, it is hard to tell the exact answer whether CitiBank is more efficient at making profits or not than its direct competitors. Even though some metrics, such as Efficiency ratio or Net Interest Margin ratio are better for CitiBank, meaning that the bank demonstrates efficiency in managing its operating expenses and has a higher net interest margin compared to its competitors, ratios such as ROA and ROE are mostly higher for the peer average group, except for 2021. Therefore, This means that CitiBank's competitors are mostly more effective at generating profit from their total assets and equity capital than CitiBank.

Conclusion

Overall, as one of the most popular banks in the U.S banking system, CitiBank is a safe financial institution that is poised to continue delivering a high level of service to its customers at the same time protecting itself from various risks the financial system and its institutions may be subject to. Over the past five years (2019-2023), in terms of efficiency and profitability, CitiBank has performed as well as its competitors, Bank of America and JP Morgan. Even though it is not generating as much income from assets and equity as its competitors it is still great at operating its expenses.

While there are many facets to CitiBank’s risk management strategy, the data observed is limited to the span of five years. Therefore it is difficult to predict the future outlook of this bank, as it has built out strong frameworks to reduce potential losses and hedge against economic shocks, but cannot predict the next shifts in the market’s landscape. However, due to its global presence, size, and diversification in risk management strategies, it is safe to assume that CitiBank will continue to be a leader in its field, especially concerning its international investments and operations.

CitiBank has been taking appropriate measures to ensure that they are managing different risk concentrations. According to the data provided earlier, Citi has taken a less risky approach compared to other prominent banks such as J.P. Morgan Chase and Bank of America. Their strategy to manage risk while trying to maintain an optimal risk appetite will help them obtain prolonged success and avoid insolvency. Therefore, Citigroup’s risk management framework will lead to long-term stability and profitability.

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