A V Rajwade: Investment banking: hazards and innovations

WORLD MONEY

Citigroup has been making headlines for all the wrong reasons.

If I remember correctly, Citibank's advertising slogan at one time was "The Citi never sleeps". The obvious reference was to Citi's worldwide operations, across all time zones.

Lately, however, the slogan has probably become more applicable to Citibank's top management! Surely they are having sleepless nights over a series of monetary damages and regulatory strictures that its activities across the globe seem to be attracting.

Citigroup is perhaps the world's most diversified financial services company, its activities ranging from insurance to commercial banking to investment banking and everything in between.

As the world's largest financial conglomerate with a net worth of around $100 billion, it would be natural for Citi to be in the news. But in recent months, it seems to making headlines for the wrong reasons:

It recently paid damages totalling $2.6 billion for claims on the bank arising from WorldCom's bankruptcy. It has separately made a provision, a couple of quarters back, of $5.2 billion against possible claims arising from Enron and other cases.

This amount still does not include any provisions against a claim of $10 billion made by the administrator of Parmalat, alleging creation of deals to disguise the company's true state of affairs.

Earlier this year, it paid a fine of $400 million arising out of claims made by New York prosecutors for giving out misleading equity research reports.

It has been rapped on the knuckles by European banking supervisors for a huge government bond sale in the European market. In an internal communication, the Citi management has confessed that, "we did not meet our standards [of probity in business practices] in this instance".

In Japan, the banking authorities have charged Citi with misleading customers in transactions involving structured bonds, cancelled its private banking licence and temporarily denied it access to Japanese government bond auctions.

The South Korean authorities have also launched an investigation into Citibank's private banking operations and some foreign exchange transactions suspected to be connected with money laundering.

Globalwest, an investment management company, has sued Citi alleging that it was involved in a scheme to destroy the value of Globalwest's investments in a couple of Brazilian telecom companies.

In India, the Reserve Bank of India recently charged Citi with violation of "know your customer" norms in respect of some accounts connected with Telgi (of stamp paper scam fame).

Financially, these issues do not matter too much "" Citi is well on its way to reporting $ 20 billion profit in the current year. But the damage to its reputation, resulting from a series of incidents, has implications for the bank in the long term.

A few top executives have been sacked, and ethics policy has been tightened. But, as the CEO acknowledged, he has further work to do to change the bank's culture.

Hard-knuckled, aggressive pursuit of business and strict adherence to ethical practices is a difficult marriage in the best of circumstances, more so for an institution as large as Citigroup.

(Incidentally, some time ago, I got a chance to study once again the securities scam of 1992 since I had been commissioned to give an expert opinion in a court case in the UK. With the benefit of hindsight, one strong feeling I ended up with was that Citi perhaps escaped the supervisor's wrath rather lightly compared to some others. Did our BoP crisis at the time have anything to do with the supervisor's attitude?)

If Citi's travails exemplify the hazards of investment banking, the other side of the business, namely continuous innovation, is also in evidence in today's world:

After currencies, bonds and equities, investment banks are making an aggressive foray into the commodities business. They are already large in the pricing and trading of aviation fuel, natural gas and so on;

The demise of Enron has not killed the market in trading electricity: the business has been taken over by major investment banks that are finding it useful to buy power plants (Goldman Sachs owns some 20 in the US) in support of their power trading activities;

The ratification of the Kyoto treaty on climate by the Russian parliament last month promises to create another big market "" in trading of environmentally-hazardous emissions.

The Kyoto treaty requires industrialised countries to bring down the levels of emission of CO2 and other gases below the levels existing in 1990. Those who fall short, can "buy" the right to continue to release higher emissions from those companies that have more than fulfilled the targeted level. Hence the market.

Even if the US has withdrawn from the Kyoto treaty, the Chicago Climate Exchange has already been established to trade futures in emissions, and is expected to start functioning from next year "" so will a European Climate Exchange.

Buying distressed assets (from banks and selling them has become a large and lucrative business for investment banks. Asia has proved a fertile ground for such business because of the large levels of NPAs in China, Japan, Korea, Indonesia and so on.

A bond that hedges the "risk" of long life "" risk, that is, for the defined benefit pension funds whose capital contributions are based on actuarial expectations of death among the pensioners year by year. The bond pays a higher coupon if the actual number of survivors turns out to be higher than actuarially predicted!

Any more innovative thoughts?

Email: avrco@vsnl.com