Citi CEO Vikram Pandit talks to The Banker editor Brian Caplen about the bank's profitable performance over the past 18 months, its cultural difficulties in Asia, how it will cope with Basel III and Dodd-Frank, and where the bank's future growth will come from.

The rehabilitation of Citi from crisis casualty to born-again global player is well under way. The bank has profitable quarters behind it and plans to return capital to shareholders in 2012. Half of its non-core assets have been sold and among its retained assets two franchises stand out as engines of future growth – the global transactions services business and the bank’s extensive presence in emerging markets.

The challenge, however, is what to do with the US consumer business, which was flagging even before the crisis. It contains the majority of the bank’s bad loans, there are questions about scale compared with rivals, and growth rates are sluggish. By contrast the emerging markets franchise – especially in key countries such as Mexico, Poland and South Korea – benefits from strong growth, low penetration and low levels of bad assets.

In a wide-ranging interview at the bank’s New York Park Avenue offices in October, Citi’s CEO Vikram Pandit outlined how the bank was making itself Basel III-friendly, how it would earn returns in excess of its cost of capital, and how its strategy was founded on getting back to basics. Mr Pandit also talked about having the right culture (the bank has recently had difficulties in Indonesia) and about rehabilitating large numbers of Americans who lost their creditworthiness in the crisis (see box).

Citi's transformation

Mr Pandit identified four elements in Citi's transformation – financial, strategic, structural and cultural. “Financial transformation is about being well capitalised, having a lot of liquidity, a lot of reserves, but also bringing the risk down significantly and having in place an asset and liability and risk framework for the future – we are basically done on that.

“The strategic transformation stage was about defining what Citi is and why the bank is important to our clients. That led to the creation of Citicorp [with the core assets] versus Citi Holdings [containing the assets for disposal] and takes us back to the basics of banking. We want to help our clients with their accounts which could be a cheque account or a cash management account or custody or prime brokerage account, and with that relationship we build we make sure we bring to them our global strength in products and services and access around the world.

“We recognised early on that the world had changed. It used to be a global world with hubs and spokes and everything went through London and New York and other financial capitals. Today a lot of the activity is point to point and that means it’s a network world,” he says.

“We have made some key strategic decisions. We decided we didn’t want to be in the western European consumer business so we sold the German consumer bank [to France’s Crédit Mutuel] and a lot of other assets. We made a similar decision that we were too large in the US consumer finance business and to downsize. There were other assets that were extremely good such as Primerica [financial services marketing] but that were not related to banking."

Generation wrecked 

In the US, the epicentre of the banking crisis, a generation has had its credit scores wrecked. On top of this, Basel III makes it tougher for banks to lend to people with low credit scores. How will they be rehabilitated?

“We need to think about how we are going to harmonise regulation with the need to promote financial inclusion,” says Citi’s CEO Vikram Pandit, long a champion of financial inclusion.

“Regulations are not written in a friendly way towards financial inclusion. For example, complying with anti-money laundering rules in the US can cost the bank $70 a client. The concern is that an increasing number of Americans will have less access to the financial system than they had before. Financial inclusion is a US problem as much as anywhere else around the world.

“We need to think about financial inclusion actively as part of our business – so with mobile banking how do we make that capability available [to the financially excluded]?

"Our goal is to create self-sustaining banking models for financial inclusion rather than thinking about it as charity. We are willing to invest and provide the seed capital to start the process but it has to be sustainable. We recognise that we don’t own the last mile and we work with partners so we may not do the mobile banking but we may provide the systems.

“The other important thing is financial education. We have a number of partnerships, for example, in San Francisco where we encourage saving and asset building. Ultimately the goal of financial inclusion is not to lend money but to get someone to open a bank account, show them how to save and build assets.”

US strategy 

Of Citi's US strategy, Mr Pandit says: “In the US we have 1000 branches in 16 cities. We don’t have the breadth of cities that other banks might have but we are in all the right cities that link [the US] to the world. For example, we are big in San Francisco, which is a hub for new immigrants with connections to the emerging markets, and Miami, with its links to Latin America.

“We are looking at the US strategy in a slightly different way now and not as a distribution-based strategy – that would require 6000 branches – instead this is more of a client-based strategy," he adds.

“We think that having a credit card business and how that is going to migrate to the Google wallet, which we just launched [a method of paying using a mobile phone], is an important part of connecting to our retail customer. Our retail business on the ground is going digital with smart branches, globally connected. We just turned on Rainbow, which is our global platform, so a client can go anywhere in the world and they will be recognised and served. This is important because the clientele we serve has linkages around the world.

“The next thing is to make sure that structurally we have the things we need to run this strategy – things such as the Rainbow system, things such as data centres, which have been consolidated from more than 60 to 20, and the cleaning up of legal entities.

“The last part is having the right culture – a culture that is focused on execution, on clients, on practising responsible finance and in bringing our creativity and ingenuity to our clients around the world. The work on culture is never done but we are today in an execution phase. Bankers need to ask themselves three questions [before doing a transaction] – is this transaction in the client’s interest, does it add any value to the client and is it systemically responsible?"

Trouble in Asia

The need to get the culture right was brought home to the bank earlier this year when Malinda Dee, a relationship manager in Indonesia, was arrested amid allegations that she siphoned $2m from the accounts of customers of Citi Gold. This is the bank’s product for affluent customers. Ms Dee’s lawyers say she admits making errors but that not all the allegations are correct. On top of this, police in Indonesia are investigating the death of a credit card holder while being interviewed by debt collectors contracted by the bank.

The Indonesian central bank responded by stopping the bank from taking on new premium customers for a year and by not issuing new credit cards for two years. External debt collection has been banned.

Citi has had other problems in Asia – in New Delhi another fraud investigation is under way and last December the bank was fined for breaching Japanese stock reporting rules. In 2004, Citi was forced to close its private banking business in Japan after being accused of violating the rules and not having proper controls, and in 2009 it was banned from selling retail financial products for a month for other failures.

Mr Pandit says: “The job on culture is never done, but you have to get the foundation right with one set of standards. You have to get the leadership right – talking the talk, walking the walk – and there has to be a reinforcing mechanism.

“You have to be ready to take tough decisions if you think somebody is playing to their game but not doing what is right for the company. In the past Citi was, unfortunately, a convenient place for some people, who had accomplished a lot of things in the world, to come in and hang out and do their thing and have a perch, but [ultimately] they were more concerned about their brand rather than the Citi brand. We have tried to put an end to that.”

Citi's progress

Bank analysts generally give Citi quite high marks for its post-crisis progress. They are particularly complimentary about the speed of disposal of non-core assets. But, as with any major bank in the current environment, there are questions about what is a realistic return on equity (ROE) given slowing growth worldwide and a plethora of new rules. Mr Pandit, like several other bank CEOs, has been quite outspoken about regulation and is very concerned about the possible lack of a level playing field.

Citibank image

When Citi announced its core/non-core plan in early 2009, non-core assets made up $650bn (or 34%) of the bank's total assets. Now the assets of Citi Holdings have declined to $300bn (or 16%) of total assets. Notable sales have included the Canadian Mastercard business and portfolios of student loans and US auto loans. There has been the initial public offering of Primerica, the wealth management joint venture with Morgan Stanley in which Citi retains a 49% stake as well as sales of Nikko Cordial Securities and Nikko Asset Management.

Christopher Wolfe, managing director for financial institutions for Fitch in New York, says: “Citi is much further along [with its disposal of the assets in Citi Holdings] than we had anticipated two years ago. We didn’t really think it could unload half the assets in that timeframe.”

Mr Pandit adds: “We took advantage of better markets and got rid of the risky portions of the portfolio. We still have $100bn of US mortgages, they will mature over time. The trading assets are more likely to be sold. The pace will be slower but it’s on its way and is well reserved. Citi Holdings is sealed from a funding, capital and reserves perspective.”

Indeed, as global markets continue to disappoint, much of the good news for Citi is coming from the Citi Holdings side of the equation. In a note on the bank’s second-quarter earnings in 2011, the analyst Creditsights says: “Citi’s earnings were largely driven by higher revenues in Citi Holdings and lower credit losses while Citicorp, the core unit, remained flattish. The higher revenues in Citi Holdings reflected positive mark-to-market marks as it benefited from improving asset valuations and markdowns incurred during the credit crisis... [while in Citicorp] improvements in consumer banking and transactions services were offset by a decline in securities and banking.” A similar story took place in the third quarter.

Where the potential lies

Then there is the onset of regulation, particularly Basel III and the Dodd Frank act. One estimate is that Citi’s risk-weighted assets would increase 35% under Basel III – 20% from Citicorp and 75% from Citi Holdings. What then is the realistic potential of the bank? “Citi Holdings is a drag on capital, not only does it not earn anything but it is a drag on capital," says Mr Pandit.

“So what is the steady state return on equity for Citi knowing that things such as Citi Holdings and deferred tax assets [penalised under Basel III] will influence short-term returns? This is how we analyse it.

“First, the global transactions services business is Basel III-friendly, it’s a big part of our business, it is growing and has a high return on equity. Second, our core retail banking philosophy of banking 150 cities means we get a clientele that has strong credit ratings and this business is also Basel III-friendly, particularly given the growth in emerging markets where two-thirds of our banking business is. Third, securities and banking is the part that is most affected for us and there are two areas that are a concern for everybody. We will be market makers and floor traders more than we will be a derivatives house. Indeed, Dodd Frank has made us all market makers [by restricting proprietary trading] and that is also more Basel-III friendly.

“Securitisation will also change. Either we will do less of it or pricing might change. Derivatives as a business will change because over-the-counter [OTC] contracts are not Basel III-friendly so either the pricing structure changes or it goes on exchanges.”

Citigroup segments

“As all this works its way through the system, we are very comfortable that if the cost of equity is 10% to 12%, good franchises such as our emerging markets and global transaction services [GTS] franchises ought to earn a premium to that. We are not going to earn 20% ROE but we think we can out earn our cost of equity.”

Joseph Scott, senior director financial institutions for Fitch, says: “The GTS business is a core strength for Citi, providing high and steady returns. The profitability of the US consumer banking business depends on the credit card business. Branch banking is not a huge contributor in the overall scheme of things.” All analysts speak well of Citi's key emerging franchises such as Banamex in Mexico, Poland’s Bank Handlowy and Citibank Korea.


Regulation challenges

Mr Pandit has been outspoken about regulation, both in the need for a level playing field across the market and in taking a common approach to trading the majority of financial instruments on exchanges – a view that sets him at odds with many of his peers in other banks.

“In certain OTC products cash never changes hands, which is why we need as many as products as possible, not only using clearing houses but also traded on exchanges. Dodd Frank only goes as far as using clearing house for some products. I am saying let’s have everything collateralised and on exchanges, which doesn’t make me a popular guy on Wall Street but it will make the system a lot safer," he says.

“With regulation, it is not enough to regulate institutions... you also have to regulate markets and networks. Our basic perspective is that there has to be a level playing field, otherwise money just flows out to the shadow banking system.”

In some ways it was assets that came from the shadow banking system – from securitisations and brokers, for example – that made the crisis so painful for Citi with the US government taking a 34% stake (now reduced to zero) in the bank. So Citi will clearly want to avoid these types of exposures, no matter what the rules are.

In a December 2010 report, Fitch noted: “Relative to many US banks, Citi’s exposure to US first mortgages and home equity loans is proportionally more moderate, thanks to its geographic breadth and diverse product mix. However, Citi’s charge-off experience has been worse than many peers due to a high proportion of US exposure originated through correspondent and broker channels and a large percentage of loans in the more problematic 2006 and 2007 vintages.”

So what of the future?

Citi's new approach to the US consumer business will be quite different. Mr Pandit says: “The credit card business can be a significant source of earnings and retail banking is in those cities where we attract a clientele that needs our services more than it needs our loans. It’s like a GTS business but for retail clients who are global and travel.

“When you combine that with digitisation, that’s a pretty powerful catalyst. We are investing in US retail so that you can go to smart banks, do things digitally and link up with the world.”

But where will the growth come from? Mr Pandit identifies the emerging markets consumer, capital formation in the emerging markets, trade finance and capital flows point to point, which could mean flows between emerging markets as well as from emerging markets into the US and Europe. Infrastructure is also an area with great potential, says Mr Pandit, as the advanced countries privatise and the emerging markets upgrade their capacity.  

“Clients in emerging markets are becoming global. A [sector] such as GTS, for example, that was started for the Exxons, Mobils and IBMs, is now being used to help the Malaysian multinational go global.”

Mr Pandit is keen to emphasise that Citi’s future growth philosophy is not based on the simple idea of a shift from developed countries to emerging markets but instead on the emergence of new trade and business flows.

“It’s not like the emerging markets can grow in isolation. There will be more trade going back and forth [between all parts of the world] and our GTS and banking businesses will be doing more for US clients as well as for emerging market clients.”


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