Citibank Latin America Training and Development Center - Introduction to Risk Management

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Introduction toRisk Management05/15/96





Introduction to RiskManagement

WarningThis workbook is the product of, and copy-

righted by, Citicorp North America, Inc. It is

solely for the internal use of Citicorp North

America, Inc., and may not be used for any

other purpose. It is unlawful to reproduce the

cont ents of these ma terials, in whole or in par t,

by any method, printed, electronic, or

otherwise; or to disseminate or sell the same

without the prior written consent of Training

and Development Centers - Asia Pacific /

CEE MEA / Lat in America.

Please sign your name in the space below.





Table of Contents





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Table of Contents

INTRODUCTION

Introduction: Risk Management Module.............................................................vii

Overview..................................................................................................... vii

Introduction to Risk Management .........................................................................xi

Overview...................................................................................................... xi

Objectives ................................................................................................... xi

Topics ......................................................................................................... xii

The Workbook ........................................................................................... xii

UNIT 1: Risk Categories

Introduction....................................................................................................................... 1-1

Unit Objectives................................................................................................................. 1-1

Major Risk Categories....................................................................................................1-2

Credit Risk .......................................................................................................................1-3

Lending Risk........................................................................................................1-4

Direct Lending Risk ................................................................................ 1-4

Contingent Lending Risk ....................................................................... 1-4Issuer Risk............................................................................................................1-5

Counterparty Risk................................................................................................1-6

Pre-settlement Risk ................................................................................ 1-6

Settlement Risk ...................................................................................... 1-7

Clearing Risk .......................................................................................................1-8

Summary — Credit Risk.....................................................................................1-8

Market Risk...................................................................................................................... 1-9

Price Risk.............................................................................................................1-9

Interest Rates .......................................................................................... 1-9

Commodity Prices ................................................................................1-10

Volatility in Options ..............................................................................1-11

Liquidity Risk .....................................................................................................1-11



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UNIT 1: Risk Categories (Continued)

Funding Liquidity Risk .........................................................................1-12

Trading Liquidity Risk ..........................................................................1-12

Market Risk in Credit-related Products ..........................................................1-12Issuer Risk ............................................................................................. 1-13

Pre-settlement / Settlement Risk ....................................................... 1-13

Summary — Market Risk .................................................................................1-13

Other Major Risks.......................................................................................................... 1-14

Equity Risk .........................................................................................................1-15

Country Risk.......................................................................................................1-15

Political (Sovereign) Risk ....................................................................1-16

Convertibility Risk ................................................................................1-16Transfer Risk ......................................................................................... 1-16

Fiduciary Risk....................................................................................................1-17

Documentation Risk..........................................................................................1-18

Disclosure Risk .................................................................................................1-18

Legal and Regulatory Risk ...............................................................................1-19

Systems Risk.....................................................................................................1-19

Summary — Other Major Risks .......................................................................1-20

Examples of Product-related Risks.............................................................................1-21Trade Finance ...................................................................................................1-21

International Securities Services — Custody.................................................1-22

Operational Risk: Settlement .............................................................1-23

Credit Risk: Settlement .......................................................................1-23

Operational Risk: Post-settlement .................................................... 1-23

Unit Summary................................................................................................................1-24

Progress Check 1 .........................................................................................................1-25

UNIT 2: Citibank's Risk Management Organization

Introduction....................................................................................................................... 2-1

Unit Objectives................................................................................................................. 2-1

Overview of the Risk Management Organization......................................................... 2-1

Management Committee................................................................................................ 2-3



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UNIT 2: Citibank's Risk Management Organization (Continued)

Credit Policy Committee (CPC)....................................................................................2-4

Market Risk Policy Committee (MRPC).......................................................................2-6

Summary Management Committee, CPC, MRPC.....................................2-8

Line Management ...........................................................................................................2-8

Credit Risk Management ...................................................................................2-9

Senior Credit Officers ...........................................................................2-11

Senior Securities Officers ....................................................................2-11

Market Risk Management ................................................................................2-12

Summary — Line Management.......................................................................2-12

Business Risk Review (BRR) ......................................................................................2-13

Portfolio Risk Assessment...............................................................................2-14

Process Assessment........................................................................................2-14

Unit Summary................................................................................................................2-15

Progress Check 2 .........................................................................................................2-17

Unit 3: Managing Credit Risk in Citibank

Introduction....................................................................................................................... 3-1

Unit Objectives................................................................................................................. 3-1

Overview of the Credit Process.....................................................................................3-2

Credit Management Model ................................................................................3-2

Phase I: Portfolio Strategy and Planning....................................................................3-4

Concentration Limits...........................................................................................3-5

Credit Policies.....................................................................................................3-6

Business Strategy...............................................................................................3-6

Target Market and Risk Acceptance Criteria ..................................................3-7

Line Management Responsibility......................................................................3-8

Phase II: Credit Origination and Maintenance ............................................................3-9

Origination............................................................................................................3-9

Evaluation.............................................................................................................3-9

Approval.............................................................................................................3-10

Monitoring and Maintenance............................................................................3-11



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UNIT 3: Managing Credit Risk in Citibank (Continued)

Problem Recognition ...........................................................................3-12

Remedial Management ......................................................................3-13

Citibank’s Credit Classification System.........................................................3-15

Distribution to Investors ....................................................................................3-17

Summary — Phases I and II.............................................................................3-18

Phase III: Performance Assessment and Reporting.................................................3-19

Portfolio Monitoring ...........................................................................................3-19

Relationship .......................................................................................... 3-19

Customer (Obligor)...............................................................................3-19

Facility .................................................................................................... 3-20

BRR Portfolio and Process Reviews ..............................................................3-21

I. Business Strategy, Staffing, and Organization ...........................3-22

II. Risk Origination and Structuring ................................................... 3-22

III. Structuring and Distribution ...........................................................3-23

IV. Transaction Monitoring, Maintenance, and Collection ............3-23

V. Portfolio Management ..................................................................3-24

Summary............................................................................................................3-24

Progress Check 3.1 ......................................................................................................3-29

Portfolio Management ..................................................................................................3-39

Objectives of a Portfolio Management System..............................................3-40

Risk Ratings.......................................................................................................3-40

Loss Norms........................................................................................................3-41

Citibank's Risk Ratings ....................................................................................3-42

Customer (Obligor) Risk Ratings ....................................................................3-45

Facility Risk Ratings .........................................................................................3-45

Risk-Adjusted Earnings....................................................................................3-46

Summary............................................................................................................3-47

Progress Check 3.2 ......................................................................................................3-49



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UNIT 4: Managing Market Risk in Citibank

Introduction....................................................................................................................... 4-1

Unit Objectives................................................................................................................. 4-1

Overview of the Market Risk Process........................................................................... 4-2

Managing Price Risk ..........................................................................................4-2

Managing Liquidity Risk .....................................................................................4-4

Funding Liquidity Risk ........................................................................... 4-5

Trading Liquidity Risk ............................................................................ 4-6

Market Risk Management Organization.......................................................................4-6

MRPC...................................................................................................................4-7

Regional Treasurer .............................................................................................4-7

Country Treasurer................................................................................................4-8

ALCO....................................................................................................................4-8

Risk Management Process............................................................................................4-9

Risk Identification..............................................................................................4-10

Risk Measurement ............................................................................................4-10

Evaluation of Risk Management Capacity .....................................................4-11

Limit Setting .......................................................................................................4-11

Ongoing Validation ...........................................................................................4-12

Limit Approval Process................................................................................................4-12Price Risk Limits ...............................................................................................4-12

Liquidity Risk Limits..........................................................................................4-13

Summary........................................................................................................................4-13

Progress Check 4 .........................................................................................................4-17

Appendix

Glossary ...........................................................................................................................G-1

Index

Index....................................................................................................................................I-1



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Introduction





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INTRODUCTION TO RISK MANAGEMENT

OVERVIEW

This self-instruction workbook provides an overview of risk management in Citibank and prepares you for the more advanced risk concepts presented in the Credit Risk Management Basics and Market Risk workbooks. When you complete the Introductionto Risk Management, you will be familiar with the risk management vocabulary, thestructure of the risk management organization, the basic credit process, and the market risk management concept in use at Citibank. The information in this workbook will bea valuable reference as you study the other workbooks.

OBJECTIVES

When you complete this workbook, you will be able to:

+ Identify the major categories of risk associated with a bank activityor product

+ Recognize the development, implementation and review process for

risk management policies in the bank

+ Define the roles and responsibilities of all groups involved in risk management

+ Identify the phases of the credit risk management process

+ Understand the fundamental issues of market risk management

+ Identify other major categories of risk related to bank activitiesand products



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TOPICS

This workbook is divided into four units:

Unit 1: Risk Categories

Unit 2: Citibank's Risk Management Organization

Unit 3: Managing Credit Risk in Citibank

Unit 4: Managing Market Risk in Citibank

THE WORKBOOK

This workbook is designed to give you complete control over your own learning. Thematerial is divided into workable sections, each containing everything you need to masterthe content. You can move through the workbook at your own pace and go back to reviewideas that you didn’t completely understand the first time. Each unit contains:

Objectives – which point out important elements in thelesson that you are expected to learn.

Text – which is the "heart" of the workbook. Thesesections explain the content in detail.

Key Terms – which also appear in the Glossary. Theyappear in bold face the first time they appearin the text.

Instructional Mapping –

terms or phrases in the left margin whichhighlight significant points in the lesson.



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] Progress Checks – which do exactly what they say — check yourprogress. Appropriate questions arepresented at the end of each unit, or withinthe unit in some cases. You will not be graded

on these by anyone else; they are to help youevaluate your progress. Each set of questionsis followed by an Answer Key. If you have anincorrect answer, we encourage you to reviewthe corresponding text and find out why youmade an error.

In addition to these unit elements, the workbook includes:

Appendix – Glossary which contains definitions of all key terms usedin the workbook.

Index – which helps you locate glossary items in theworkbook.

Since this is a self-instruction workbook, your progress will not be supervised. Weexpect you to complete it to the best of your ability and at your own speed. You areready to begin!



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Unit 1





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UNIT 1: RISK CATEGORIES

INTRODUCTION

Risk management is a necessary element in achieving Citibank's objectives. Risk-takingactivities are intended to increase earnings. However, they can result in a loss of revenue,and may even damage the bank's reputation. It is important to understand the risks we takeand to manage them systematically. In this unit, you will learn the major categories of risk that affect our business and the common risk vocabulary that allows us to communicateabout risk.

UNIT OBJECTIVES

When you complete this unit, you will be able to:

n Identify the major categories of risk in banking

n Identify specific types of risk which fall into each category

n Match some types of banking activities or products with their predominantrisk categories



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MAJOR RISK CATEGORIES

A knowledge of the major risk categories and an ability to identify,assess, and control the risks that are inherent in transactions areessential prerequisites for developing an effective risk managementsystem. In this unit, we will introduce the major categories of risk, thetypes of risk in each category, and certain risks that are inherent insome banking activities. The risks are grouped as follows:

n Credit Risk

n Market Risk

n Other Major Risks

Figure 1.1 illustrates these risk categories with some of the specificrisks that are associated with each category. This list does not includeall possible risks associated with the bank's business. Other normalrisks found in every business activity include operations andtechnology, legal, tax, and human resources. These, too, must beidentified and managed by the responsible Line Manager.



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Figure 1.1: Major categories and sub-categories of risk

CREDIT RISK

Credit risk is the risk that financial obligations to Citibank will notbe paid on time and in full as expected or contracted, resulting in afinancial loss for the bank. Credit risk is a customer-related risk because the dimension of the risk depends on the customer'swillingness and ability to fulfill all obligations to the bank. Thereare six types of credit risk:

n Direct lending risk

n Contingent lending risk

n Issuer risk



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n Counterparty pre-settlement risk

n Counterparty settlement risk

n Clearing risk

Lending Risk

Associated with

extensions of

credit

Lending risk is associated with extensions of credit and/or credit-sensitive products, such as loans and overdrafts, where the bank bears thefull risk for the entire life of the transaction. There are two types of lending risk: direct and contingent.

Di rec t Len din g Ri sk

Direct lending risk is the risk that actual customer obligations willnot be settled on time. Direct lending risk occurs in products rangingfrom loans and overdrafts to credit cards and residential mortgages. Itexists for the entire life of the transaction.

C on t i n g en t L e n d i n g R i sk

Contingent lending risk is the risk that potential customerobligations will become actual obligations and will not be settled ontime. Contingent lending risk occurs in such products as letters of credit, and guarantees. It exists for the entire life of the transaction.



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Example Let's look at an example that illustrates contingent lending risk. ABC, Inc.,a government-owned oil company, contracts with LMN Builders, Inc. toconstruct an oil refinery in that country. As part of the contract, ABC

demands that LMN obtain a letter of credit from its bank with ABC as

beneficiary. The letter of credit states that upon the first written demandfrom ABC indicating that work has not been performed according to thecontract, the bank will pay ABC. Up to this point, the obligation is acontingent risk for the bank – it only has to pay if ABC makes aclaim.Once the bank pays ABC, then the obligation becomesa loan to LMN which LMN is expected to repay.Although LMN

indemnifies the bank against such payment, the bank has a direct lendingrisk that LMN will not pay.

Issuer Risk

Associated with

underwriting and

distribution

Issuer risk occurs in underwriting and distribution activities when thebank commits to purchase a security or other debt instrument from anissuer or seller and there is a risk that the instrument cannot be soldwithin a predetermined holding period to an investor or purchaser. If this happens, the bank as the holder of the instrumentis exposed to direct lending risk and unintended price risk .

Issuer risk is the risk that the market value of a security or other debt

instrument that the bank intends to hold for a short period of time maychange when the perceived or actual credit standing of the issuerchanges, thereby exposing the bank to a financial loss. Issuer risk isinterrelated with price risk. (See page 1-7).



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For example, let's look at a situation that could occur in the US.Suppose that BigShop needs financing, and Midtown Bank agrees tounderwrite a fixed-rate mortgage. Midtown does not intend to hold themortgage on its books but, instead, plans to sell the mortgage within

30 days to investors.In this situation, Midtown first has price risk,which is the risk that interest rates will rise before the bank sells thebonds. If interest rates rise,the value of the fixed-rate bonds will dropand Midtown will suffer the loss.Second, Midtown has credit risk,which is the risk that the perceived or actual credit standing of BigShop will deteriorate before the bank sells the bonds. If BigShop'scredit standing deteriorates, interest rates will rise only for BigShop.The effect on the value of those bonds and the P & L of Midtown Bank will be the same as if interest rates in general had risen in themarketplace.

Counterparty Risk

A counterparty is a customer with whom we have a contract tosimultaneously pay each other agreed values at a stated future date.

Pre-se t t l ement R i sk

Risk of customer default before

contract value

date

Pre-settlement risk is the risk that a counterparty may default on acontractual obligation to the bank before settlement date of thecontract. Pre-settlement risk is measured in terms of the currenteconomic cost to replace the defaulted contract with anothercustomer (known as "current mark-to-market") plus the possibleincrease in the economic replacement cost due to future marketvolatility (known as the "maximum likely increase in value").

When a counterparty defaults on a contract obligation during thecontract before the settlement or maturity date, the bank must find

another counterparty at the current market rate. The bank is exposed topossible adverse price fluctuations between the contract price and themarket price on the date of default. If the prevailing market rate is lessattractive than the contract rate, the bank faces a possible loss.



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As an example, let's assume that Bank XYZ needs to buy US dollarsforward 90 days at a rate of 1US$ = Yen 120. Forty-five days into thecontract, the seller informs Bank XYZ that she has declaredbankruptcy. Bank XYZ must buy the dollars from a new seller at the

current market rate of 1US$ = Yen 130. The bank experiences a lossof 10 Yen per US$ on the transaction.

Pre-settlement risk belongs to the family of credit risk because theprimary consideration is the creditworthiness of the counterparty —the judgment of counterparty creditworthiness is a credit issue.However, the size , or level, of pre-settlement risk is calculated based

on the likely expected change in market prices. Therefore, the judgment of credit risk factors is a market risk issue.

S e t t l em e n t R i s k

Risk of customer

default on

contract

value date

Settlement risk occurs on the maturity date when the bank simultaneously exchanges funds with a counterparty for the same valuedate and cannot verify that payment has been received until after thebank's side of the transaction has been paid or delivered. In today'sinternational banking environment, the different time zones betweencountries make it difficult to achieve a simultaneous exchangebetween counterparties.

The risk is that we deliver our side of the transaction but do notreceive delivery and, therefore, are exposed to direct lending risk. Inthis situation, at least 100% of the principal amount is at risk. The risk may be larger than 100% if, in addition, there has been an adverseprice fluctuation for us between the contract price and the marketprice.

Suppose Bank XYZ delivers the Yen at maturity of the forwardcontract. Due to time zone differences between Japan, where the

Yen have to be paid, and New York, where the US dollars are to bereceived, Bank XYZ experiences a settlement risk (at least 100%)for a period of 12 hours longer than normal.



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In this case, the risk is more than 100% because the market price for1US$ has moved from 120 to 130 Yen before the contract is settled.If the counterparty fails to deliver the dollars, Bank XYZ will have toreplace the dollars (100% of the principal) at the higher rate.

Therefore, the risk is actually more than 100%.

Clearing Risk

Clearing risk is the possibility that the bank may not be reimbursedon the same value date for payments that are made on behalf of customers. Clearing risk occurs when the bank acts on a customer'sinstructions to transfer funds before being reimbursed.

Summary — Credit Risk

Credit risk is a customer-focused risk related to a customer'sfulfillment of financial obligations to the bank. The size of issuer risk

and pre-settlement risk is linked to market risk. Likewise, credit risk incorporates, or is closely linked with many other risks which must berecognized and dimensioned.

In contrast to credit risk management, which focuses on the customer,market risk management focuses on market prices and liquidity. Inthe next section, we will discuss three market factors that give rise toprice risk. We will also define the two types of liquidity risk.



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MARKET RISK

The shift in the business emphasis in banking to include both lendingtransactions and trading transactions has caused an increase in the needto identify and manage market risks. Market risk is a generic term forprice risk and liquidity risk. Price risk is the potential earningsexposure arising from changes in market rates. Liquidity risk is therisk that the bank will be unable to meet financial commitments whenthey are contractually due.

Price Risk

Price risk exposure is the sensitivity of earnings to changes in threetypes of market factors:

n Interest rates

n Commodity prices (including foreign currencies and equities)

n Volatilities in options

As in any risk situation, the size of price risk must be related toexpected revenues in order to allow risk / return analysis.

In t eres t R at es

Sensitivity to

changes in the

yield curve

The yield curve represents the relationship between interest rates(yield) and time to maturity. Interest rate fluctuations affect the valueof all interest rate-sensitive positions. Some positions are moresensitive to the level of interest rates and some are more sensitive to

the differential between rates.*

n Changes in the level of the yield curve for a specific instrumentaffect interest rate level sensitive positions.



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n Changes in the spread between yield curves for two differentinstruments with the same maturity, or for two differentmaturities in the same instrument, affect interest rate

differential sensitive positions.

*For details on yield curve and interest rate level and interest ratedifferential-sensitive positions, see the Market Risk Managementself-instruction workbook.

Com m odi ty Pr ices

Price changes

affect value of

net positions

Changes in commodity prices can affect the value of net positions in

foreign currencies, equities, precious metals and other commodities.A net position is the difference between assets plus any unliquidatedpurchases on one side and liabilities plus any unliquidated sales on theother side in a given commodity.

Assets + unliquidated purchases- Liabilities + unliquidated sales

= Net Position

Net FX position A foreign currency net position is overbought when assets plus

unliquidated purchases in a currency exceed liabilities plusunliquidated sales in the same currency; a net position is oversoldwhen liabilities plus unliquidated sales exceed assets plus unliquidatedpurchases. Net position risk is the risk that there willbe adverse fluctuations in currency values when we hold a netoverbought or net oversold position. Currency fluctuations aretypically influenced by economic and/or political events in the world.



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Vola t i l i t y i n O p t i on s

Affects the value

of an option

Volatility in options is a market-focused risk associated with themagnitude of expected changes in the market price of the "underlying"

to which the option relates. Higher expected volatility increases thevalue of an option and lower expected volatility decreases the value of an option.

The model used to calculate an option premium requires fivevariables: strike price, market price, time to maturity, money marketinterest rate, and volatility of the price of the underlying. The first fourvariables are known. The only unknown variable is volatility, whichreflects the market's estimate of future movements in the price of theunderlying. Since four variables are known and one (volatility) is not

known, we can see why volatility in options is an independent marketprice and, therefore, trading options is trading volatility.

Technically, volatility is defined as the standard deviation of expectedchange in the price of the underlying expressed in percent per annum.In other words, volatility relates to the likely trading range of anoption's price given the uncertainty of price movements of theunderlying.

Future estimated volatility may be derived from options-impliedvolatility, historical data on price movements, or reasonedmanagement judgment.

Liquidity Risk

Liquidity risk is the risk that the bank may be unable to meet itsfinancial commitments to customers or other market participants.Liquidity exposures may arise in both funding and trading activities.




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F u n d i n g L i q u i d i t y R i sk

Inability to

meet obligations

when due

Funding liquidity risk is the risk that funds will not be available tomeet financial commitments when they are contractually due.

For example, Bank A borrows $1 million for 30 days from Bank B andlends it to Bank C for 90 days. After 30 days, Bank A has to repay theborrowed funds to Bank B or borrow again for another 30- or 60-dayperiod. Bank A's risk is that it will be unable to renew the 30-dayborrowing to match the remaining 60-day period of the loan to Bank Cand, therefore, will not have the available cash flow to repay the fundsto Bank B.

The monitoring of funding liquidity also tracks the availablity of fundsto take advantage of attractive business opportunities.

T r a d i n g L i q u i d i t y R i s k

Inability to

liquidate a

position to meet

funding needs

Trading liquidity risk is the risk that the bank will not be able toinstantly liquidate price risk positions without changing market prices,attracting the attention of other market participants, or compromisingon counterparty quality. The inability to liquidatea position quickly may impair funding liquidity or cause losses in

situations where we have a substantial price risk position that cannotbe liquidated before the market price changes.

Market Risk in Credit-related Products

There are two businesses belonging to the family of credit risk inwhich the size of the risk is largely determined by changes in marketprices. These two businesses are underwriting, which generates issuer

risk, and distant value date products (forwards, swaps, and purchasedoptions) which generate pre-settlement and settlement counterpartyrisk.




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I ssu er Ri sk

Issuer risk in underwriting activities involves market risk in addition tocredit risk. There is a risk that market prices will move against us

between the time we agree to purchase and actually purchase an equityor debt instrument. There is also a risk that market prices will moveagainst us while we hold an instrument or between the time we agreeto sell and the time we actually deliver the instrument.

Pre-se t t l emen t / S e t t l emen t R i sk

As we said in the counterparty risk section, pre-settlement / settlement risk occurs when an adverse market rate change occurs

after a distant date transaction has been agreed upon. Specifically, weare at risk if the change in the market rate results in a situation wherethe contract rate is more favorable to us than the prevailing marketrate. Since the change in the market rate causes the pre-settlement / settlement risk, the determination of the size of this risk is a marketrisk issue.

In underwriting as well as distant-date trading, the approval of thecounterparty and the extent to which the bank wishes to extend creditto such parties is exclusively a question of credit risk.

Summary — Market Risk

Market risk is made up of two elements: price risk and liquidity risk.Price risk is the risk associated with changes in market factors thataffect the value of all positions. These factors include interest rates,commodity prices, and volatility in options.




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Liquidity risk is the risk that Citibank will not be able to meet financialcommitments to customers or other market participants when they aredue. There are two types of liquidity risk. Funding liquidity risk is therisk that the bank will not have the funds available to fulfill its financial

obligations. Trading liquidity risk is the risk that the bank will beunable to liquidate assets or will haveto liquidate at a loss for funding purposes.

Whenever market risk is assumed, the size of this risk must bedimensioned and related to the expected revenues in order to assurea satisfactory risk / return ratio.

Even though issuer risk and pre-settlement / settlement risk wereintroduced as credit risks, both types of risk have substantial market

risk components — the size of these risks depends on changes inmarket prices.

In addition to credit risk and market risk, other major risks associatedwith the bank's activities must be managed. In the next section, we willdiscuss some of these risks.

OTHER MAJOR RISKS

Other major risks that must be identified and managed include:

n Equity

n Country (including political risk and transfer risk)

n Fiduciary

n Documentation

n Disclosure

n Legal and regulatory

n Systems




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In the remainder of this unit, we will describe each of these risk categories.

Equity Risk

Risk of fluctuation

in value of

equities

Equity risk occurs when the bank invests in, holds, or receives equity,equity-like securities, or other junior securities in non-affiliatedentities. These securities include instruments such as common shares,preferred shares, and related derivative instruments such as warrants,stock options, calls, and stock index futures.

For example, Builders, Inc. decides to issue shares of stock and asksBank XYZ to manage the underwriting of these shares. Many shares

are sold to other investors, but Bank XYZ keeps a portion of them and,thus, becomes a shareholder in Builders, Inc. If Builders does well, thevalue of the shares may increase; but if the company experiencesadverse business conditions, the value of the shares may decrease.XYZ, along with the other shareholders, is risking a fluctuation in thevalue of the stock.

Country Risk

Country risk is a broad risk category that includes political risk,convertibility risk (also known as cross-border risk), and transfer risk.




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Pol i t i ca l (Sovere ign) R i sk

Government

actions or

independentevents

Political risk is the risk that the actions of a sovereign government (suchas nationalization or expropriation) or independent events (such as war,

riots, or civil commotion) may affect the ability of customers in thatcountry to meet their obligations to Citibank. Nationalization orexpropriation risk exists when a government action deprives a borrowerof access to significant assets, or prevents the borrower from operatingall or part of its business.

Conver t ib i l i t y R i sk

Prohibition of

converting currencies

Convertibility risk exists in any transaction in which the borrower is

unable, due to laws or regulations, to convert its local currency into theforeign currency of the payment when the obligation in that currencymatures.

For example, when Citibank in Brazil advances local currency to a

textile firm in Brazil, Citibank has credit risk the risk that thetextile firm (borrower) will not generate sufficient funds to repay thedebt. However, when Citibank in London advances pounds to the sametextile firm in Brazil, Citibank has an added risk. Even if the Braziliantextile firm generates enough funds in local currency, there is still the

risk that the Central Bank of Brazil may prevent the conversion of local currency into pounds to service the debt in London.

T r a n s f e r R i s k

Prohibition of

funds movement

Transfer risk is the risk that a borrower will be unable (due to legal orpayment barriers) to move funds in the foreign currency of a transactionwhen an obligation in that currency matures.




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Even if the Brazilian textile firm generates enough funds in localcurrency and can convert them into pounds, there is still the risk that theCentral Bank of Brazil may prevent the transfer of converted funds toLondon to service the claim.

Fiduciary Risk

Acting on

behalf of a

third party

Fiduciary risk occurs when the bank is charged with the responsibilityof acting as a trustee for any third party. The risk is reduced by havinga trust agreement that clearly defines our duties and responsibilities andspecifies when we may be exposed to potential or real conflicts of interest.

Whenever Citibank acts primarily for the benefit of a third party, it isacting in a fiduciary capacity. For example, the bank may serve as aninvestment advisor or portfolio manager of an account. In thatcapacity, it may be authorized to select the securities or otherproperties that should be purchased, sold, or retained. Some of the risk factors inherent in fiduciary responsibility include:

n Failure to establish a clear agreement in the documentation,which could result in the bank being charged with inappropriateconduct

n Failure to disclose all relevant information, which could result ina client charging the bank with breach of fiduciary duty

n An actual or potential conflict between the bank's interest and itsfiduciary responsibility

n Failure to comply with applicable policies or laws




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Documentation Risk

Unenforceable

documentary

evidence

Documentation risk is the risk that the documentary evidence onwhich we depend to enforce our rights under contracts or transactions

may not be complete, correct, or enforceable.

For example, Bank XYZ grants a loan to Builders, Inc. and asks Builders,Inc. to sign a promissory note. Mr. Smith of Builders signs the note, buthe is not authorized by the company to do so. The note becomesunenforceable, and the bank may not be able to use the documentation asproof of claim if Builders, Inc. defaults on the loan.

Disclosure Risk

Improper

information

reporting

Disclosure risk occurs when we act as an agent for other investors,either as an underwriter or as an advisor on a transaction. The bank is required to disclose certain information, and the risk is that we:

n Disclose information that we either know or should have knownto be incorrect

n Do not disclose actual or potential conflicts of interest

n Do not disclose or delay in disclosing material information

n Disclose information without authorization from the client

n Fail to investigate and evaluate the borrower and the transaction

For example, suppose Builders, Inc., approaches Midtown Bank foranother loan. Midtown Bank wishes to check Builders, Inc.'sreferences, so it calls Bank XYZ and requests information regardingBuilders, Inc.'s account. Bank XYZ confirms that Builders has been agood customer and reveals that they have a healthy deposit account of $1,823,000. Unfortunately, Bank XYZ is not authorized to discloseBuilders, Inc.'s deposit account balance, and once again, Bank XYZ isin trouble.




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Legal and Regulatory Risk

Regulatory, civil,

or criminal

sanctions orlitigation

Legal and regulatory risk occurs whenever the bank, a relatedcorporate entity (such as a non-bank subsidiary or affiliate), a

transaction, or a customer is subject to a change in exposure resultingfrom regulatory, civil or criminal sanctions, or litigation. Strictcompliance with all relevant regulations is one of Citibank's corevalues and is essential to our reputation and success.

When a transaction does not comply with all the applicable laws andregulations, the bank may face civil, criminal, and administrativeproceedings and may also be fined.

For instance, suppose that Builders, Inc. wishes to borrow $1,000,000to finance a new construction project. Bank XYZ agrees to do this anddraws up a contract for that amount. However, Bank XYZ and Builders,Inc. are located in a country which imposes a legal lending limit of 5%, meaning that Bank XYZ cannot loan more than 5% of its capital toone customer. The current capital of Bank XYZ is $10,000,000, so itis legally allowed to loan Builders, Inc. only $500,000. Exceeding thelegal lending limit may subject the bank to a sanction or fine.

Systems Risk

Operational

aspects of a

product

Systems risk refers to those risks arising from the operationalaspects of the product, including systems which can be both externaland internal to the bank. In many instances, these risks are associatedwith the use of technology.

An example of an external system is a money transfer system. Whenthe bank transfers funds by wire, it may use private internationalcommunications systems such as the Society for WorldwideInternational Financial Telecommunications (SWIFT). Whenever thebank's operations use these systems, there is a risk that a disruption of services may occur.




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"Internal systems" applies to the operational infrastructure

data processing center, premises and facilities services, and

telecommunications network managed by the bank. If there isa major failure in one institution, the impact may be felt in other

institutions. For example, in 1991 there was a fire at a utilitysubstation in New York which caused interruption of services atCitibank, and at all other banks in New York, for three to five days.

Summary — Other Major Risks

In this section, we identified some other major risks associated withdifferent types of banking activities.

Equity risk is the risk that the value of equities will fluctuateadversely.

Political or sovereign risk results from government actions orindependent events in a country.

Transfer or cross-border risk is the risk that funds either cannotbe converted into foreign currency funds or that converted fundscannot be moved past an exchange control border.

Fiduciary risk arises from acting for the benefit of a third party.

Documentation risk is the risk that documentary evidence of atransaction is incorrect, incomplete, or cannot be enforced.

Disclosure risk arises from the bank's obligation to reportinformation when acting as an agent for other investors.




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Legal / regulatory and systems risks are inherent in all bankingtransactions. The bank is responsible for making sure that alltransactions comply with US and other relevant country systems of law, taxation, regulation, and accounting. Legal risk is inherent in

documentation preparation, regulation adherence, disclosureprocedures, and exposure to litigation. There is also the risk thatsystems or people within the bank will fail to provide adequateinformation and processing support for transactions.

EXAMPLES OF PRODUCT-RELATED RISKS

Each bank product has specific risks associated with it. Theprofitability of a transaction depends on our ability to recognize,analyze, and manage the risks. Let's look at two examples of risksassociated with specific transactions.

Trade Finance

In this example, we will examine some of the risks associated with atrade finance transaction in which an exporter receives advancepayment for future shipments.

Suppose an exporter in Spain receives an advance of US$5MM todayfrom Citibank, New York, for goods that will be shipped to a USimporter nine months from now. The US importer agrees to pay theprincipal amount in US dollars to Citibank, N.Y., upon receiving theshipments. The exporter agrees to pay the interest. He will convertSpanish pesetas into US dollars through the local Citibank branch, whichwill remit the interest payments to Citibank, N.Y.




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Shipments to the importer begin in nine months and take place over aperiod of two months. For each shipment received, the importer hasthirty days to remit the corresponding payment to Citibank , N.Y. In themeantime, the exporter pays Citibank, N.Y. 10% p.a. interest on the

balance due. This rate is a function of the risks associated with thetransaction and the cost of mitigating the risks.

The risks for Citibank associated with this transaction are:

n Performance Risk: Risk that the exporter is not able to producethe goods or to pay the interest on the balance due

n Credit Risk: Risk that the importer is unable to pay all or partof the principal

n Political (Sovereign) Risk: Risk that the exporter is unable toexport due to local government actions such as confiscation,expropriation, or nationalization

n Transfer (Cross-border) Risk: Risk that the exporter is unableto convert local currency to US$ to pay interest on balance due

International Securities Services — Custody

Securities custody is the set of services provided to an investor orsecurities intermediary after a trade is executed. Custody includessecurities transaction settlement, cash management and foreignexchange, reporting, safekeeping, and processing of income collectionand corporate actions.

Customers purchase securities custody as a transaction processingproduct and to reduce risk; contractually, Citibank assumesresponsibility for customer losses caused by the bank's negligence.

Therefore, in addition to normal operational and credit risks, weshould consider actions or omissions that could increase customerrisks. Let's look at some examples of risks associated with custody.




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O pera t i ona l R i sk : S e t t lem en t

Super Securities, a major broker–dealer in New York, buys Argentinestocks through its broker and sends instructions to Citibank Argentina

to receive the securities against payment. Citibank in Buenos Airesfails to "pre-match" the transaction (verify or compare the details) withthe broker in advance. When the settlement deadline approaches,Citibank discovers that the broker is expecting to receive $100,000more than Citibank has been instructed to pay. Since it is too late tocheck with Super Securities, Citibank "fails" the transaction (does notpay). The next day the broker claims penalty interest on the entiretransaction amount from Super Securities, which, in turn, claims itfrom Citibank.

Cred i t R i sk : Se t t l em en t

An investor customer of State Street Bank and Trust sells MexicanGovernment bonds through a Mexican broker, and State Streetinstructs its custodian, Citibank Mexico, to deliver the bonds againstpayment. Although the broker has a current account with Citibank, ithas no approved credit lines in place. At 4:00 p.m., which is the marketdeadline for settlement of bonds, Citibank finds that the broker doesnot have sufficient funds in its account. The broker advises that it has

checks in transit to cover the shortfall; Citibank delivers the bonds. Atthe end of the day, the funds fail to arrive to cover the overdraft.

Opera t iona l R i sk : Pos t -se t t l emen t

The Brazilian telecommunications giant, Telebras, announces a rightsissue. Citibank Sao Paulo fulfills its obligation of advising allcustomers, but it misplaces a record of the fax transmission to one of its customers in London. The day the rights issue closes, the London

customer calls Citibank, Sao Paulo, claiming it was never advised of the action and demanding compensation of $300,000 to compensatefor the loss of a valuable opportunity to exercise its rights under veryfavorable market conditions.




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These examples illustrate that, in addition to identifying andcontrolling the bank's risk-taking activities, we must also look atcustomer risks; if we don't, they may become risks for the bank.

UNIT SUMMARY

The major categories of risk are: credit risk, market risk, and othermajor risks, including equity, country, fiduciary, documentation,disclosure, legal / regulatory, and systems risk.

Legal / regulatory and systems risks affect all transactions. Credit

risks are customer-focused they are related to the customer's

willingness and ability to fulfill obligations. Market risks are market-focused they relate to fluctuations in market prices, such asinterest rates, foreign exchange rates, and volatilities in options. Otherrisks are related to the specific type of transaction.

You have completed Unit One: Risk Categories. Please complete the following ProgressCheck before continuing to Unit Two: Citibank's Risk Management Organization. If you

answer any Progress Check question incorrectly, you should return to the text and read thecorresponding section again.




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þ PROGRESS CHECK 1

Directions: Select the correct answer for the following questions. There is only onecorrect answer unless otherwise stated in the question. Check your answerswith the Answer Key on the next page. If you answer any of the questionsincorrectly, return to the appropriate section of the text and review thematerial.

Question 1: In the spaces below, write the major risk categories. You may select from thefollowing list:

Clearing Commodity Prices Systems Direct

Pre-settlement Fiduciary Country Issuer

Lending Interest Rate Trading Equity

Disclosure Contingent Political Price

Volatility in Options Documentation Funding Settlement

Transfer Legal & Regulatory Liquidity Counterparty

Convertibility




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ANSWER KEY

Question 1: In the spaces below, write the major risk categories. You may select from the

following list:

Clearing Commodity Prices Systems Direct

Pre-settlement Fiduciary Country Issuer

Lending Interest Rate Trading Equity

Disclosure Contingent Political Price

Volatility in Options Documentation Funding Settlement

Transfer Legal & Regulatory Liquidity Counterparty

Convertibility




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PROGRESS CHECK 1(Continued)

Question 2: Below are descriptions of some major risk categories. Beside eachdescription, write the risk category it defines.

a) Any transaction which involves moving moneythrough an exchange control barrier has this risk.

b) A bank must be sure to comply with all laws andregulations to guard against this risk.

c) Banks must study the market carefully to reduce thisinvestment risk.

d) All operating functions, such as data processing,telecommunications, etc. should be supervised to besure they are running smoothly and accurately.

e) Because market factors change, a bank mustconsider how market fluctuations will affect aposition.

f) When a bank makes a loan, it must make sure that thecustomer will be able to fulfill all obligations.




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ANSWER KEY

Question 2: Below are descriptions of some major risks. Beside each description, writethe risk category it defines.

a) Transfer Any transaction which involves moving moneythrough an exchange control barrier has this risk.

b) Legal A bank must be sure to comply with all laws andregulations to guard against this risk.

c) Equity Banks must study the market carefully to reduce thisinvestment risk.

d) Systems All operating functions, such as data processing,telecommunications, etc. should be supervised to besure they are running smoothly and accurately.

e) Price Because market factors change, a bank mustconsider how market fluctuations will affect aposition.

f) Credit When a bank makes a loan, it must make sure that thecustomer will be able to fulfill all obligations.




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Question 3: The type of transaction largely determines the predominant risk associatedwith it. Several types of transactions are described below. Beside eachdescription, write the letter of the predominant risk incurred in thattransaction.

a) Issuer Risk

b) Pre-settlement Risk

c) Liquidity Risk

d) Fiduciary Risk

e) Documentation Risk

The bank buys dollars forward 90 days against local currencyfrom an exporter. After 30 days, the exporter goes bankrupt.

The treasurer decides to borrow money short-term, whilelending long-term. He expects the rates to go down. One week later the monetary authority imposes severe restrictions onthe money supply, making it difficult for the treasurer torenew short-term borrowing.

While reviewing a loan contract and promissory note, theaccount manager realizes that the note has been amended.According to local law, this means the note is nowunenforceable.

The bank accepts a mandate to manage a customer's pensionfund portfolio.

The bank buys some marketable securities, but soon theoriginator of the securities starts to have financial problems.




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ANSWER KEY

Question 3: The type of transaction largely determines the predominant risk associated

with it. Several types of transactions are described below. Beside eachdescription, write the letter of the predominant risk incurred in thattransaction.

a) Issuer Risk

b) Pre-settlement Risk

c) Liquidity Risk

d) Fiduciary Risk

e) Documentation Risk

b The bank buys dollars forward 90 days against local currencyfrom an exporter. After 30 days, the exporter goes bankrupt.

c The treasurer decides to borrow money short-term, whilelending long-term. He expects the rates to go down. One week later the monetary authority imposes severe restrictions on

the money supply, making it difficult for the treasurer torenew short-term borrowing.

e While reviewing a loan contract and promissory note, theaccount manager realizes that the note has been amended.According to local law, this means the note is nowunenforceable.

d The bank accepts a mandate to manage a customer's pensionfund portfolio.

a The bank buys some marketable securities, but soon theoriginator of the securities starts to have financial problems.



Unit 2





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UNIT 2: CITIBANK'S RISK

MANAGEMENT ORGANIZATION

INTRODUCTION

After the risks of a transaction have been identified, we estimate the probability that eachrisk will materialize, evaluate its potential impact on our business, and develop a plan tominimize it. In this unit, you will learn about the different groups that participate in the risk management process. You will also see how the policies, rules, and procedures for the risk management process are implemented, enforced, and reviewed in Citibank.

UNIT OBJECTIVES


n Identify the organizational groups involved in risk management

n Recognize the roles of each group in the risk management process

n Describe the general responsibilities of each group

OVERVIEW OF THE RISK MANAGEMENT ORGANIZATION

Decentralized

process

Risk management in Citibank is a decentralized process guided by

centrally established policies and rules. Senior staff committeesdefine our credit and market risk culture and establish overall policiesand rules. Line Management manages and controls risk.



2-2 CITIBANK'S RISK MANAGEMENT ORGANIZATION

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Five

organizational

groups

There are five major organizational groups that participate inCitibank's risk management process. These groups are responsible fordefining, implementing, and/or reviewing risk management policies,rules, and procedures within Citibank:

n Management Committee

n Credit Policy Committee (CPC)

n Market Risk Policy Committee (MRPC)

n Line Management

n Business Risk Review (BRR)

The Management Committee establishes the risk tolerance level forthe bank and sets the goals and objectives for risk managementactivities. The Credit Policy Committee (CPC) and Market Risk

Policy Committee (MRPC) establish policies and rules thatcommunicate the strategy for achieving the goals and objectives setforth by Senior Management. Line Management is responsible fordeveloping procedures to implement the policies and rules establishedby the CPC and MRPC. Finally, the Business Risk Review (BRR)

group reviews the policies and rules set by the CPC and MRPC andalso reviews the practices against the standards of Line Management

to ensure that portfolios are structured and managed to achieveManagement Committee's goals.



CITIBANK'S RISK MANAGEMENT ORGANIZATION 2-3

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Figure 2.1: Risk management organization

In the sections that follow, we will discuss the roles and generalresponsibilities of each group.

MANAGEMENT COMMITTEE

Sets risk

tolerance

levels and

goals /

objectives

As the highest decision-making body within Senior Management,the Management Committee allocates key corporate resources. Itsleadership drives our corporate and credit cultures. The ManagementCommittee's role in the risk process is to:

n Establish the bank's overall risk capacity

n Set strategic targets and aggregate limits at the corporate level

n Review individual credit and market decisions that posepotentially material risks to the bank's franchises, businessstrategy, risk concentrations, or reputation

MANAGEMENT COMMITTEE

+ Risk tolerance level

+ Goals for risk management activities

LINE MANAGEMENT

+ Procedures

+ Implementation

CREDIT POLICY COMMITTEE

+ Policies and rules

BUSINESS RISK REVIEW

+ Reviews

+ Recommends

corrective action

MARKET RISK POLICY

COMMITTEE

+ Policies and rules




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CREDIT POLICY COMMITTEE (CPC)

Establishes

policies for

credit risk and

equity risk

The CPC is a senior-level staff group that establishes policies forcredit risk and equity risk. These include approval hierarchies, rulesand standards covering credit products, and limits for portfolioconcentrations.

CPC issues the Citibank Core Credit Policies (CCCP) manual thatincludes an overview of Citibank's credit philosophy, a summary of thecredit policy development process, the organization and phases of thecredit process, approval rules, and specific credit policies. The CPC

updates the core credit policies and rules and then communicates thechanges by issuing replacement pages for the CCCP document. Inaddition, Line Management consults with the chairman or a memberof CPC in accordance with CCCP.

The committee's responsibilities include:

n Maintaining a sound, effective credit risk structure

n Participating in portfolio planning and credit loss forecasting

n Establishing, reviewing, and updating credit polices and standardsthat conform to applicable law, regulations, and corporate policies

n Reviewing and approving exceptions to core credit policies thatrepresent unusual risk

n Keeping aggregate credit risk within the Bank's risk-taking capacity

n Granting approval authority to skilled, highly qualified individuals

n Reviewing the adequacy of credit training across the bank*

*[Core Credit Policies — September, 1992]

Reporting

responsibilities

The Chairman of the CPC reports to the Chairman of Citicorp / Citibank and provides reports on credit to the Management Committeeand the Board of Directors. The reports include:




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n Policy exceptions reviewed by CPC that have implications forsignificant policy considerations

n Portfolio reviews including quality assessment, risk profiles,

tenors, concentrations, and any excesses over limits

n Problem credits consistent with Board and regulatoryrequirements

Monitoring and

advisory role

The CPC also acts as one check and balance for the credit process.The committee monitors ongoing risk management activities and actsin an advisory capacity when needed.

It is CPC's responsibility to ensure that the bank's business is

conducted within the risk-taking parameters established by theManagement Committee. CPC monitors the quality or performance of the credit portfolio and looks for unusual trends or concentrationsrelated to such factors as geography, business segment, industryexposure, currency mix, tenor, risk categories, and risk levels.

To facilitate the implementation of its policies and rules, CPC alsointeracts in an advisory capacity with Line Management. In this role,CPC:

n Assists Line and Senior Management in maintaining a balancedportfolio within the parameters of the bank's tolerance for risk

n Participates with Line groups in business planning and reviewstarget market concentrations, unusual marketing strategies, andother questionable risk characteristics

n Oversees, with Business Risk Review, the implementation byLine Management of recommended improvements in the creditprocess that result from reviews

Staffing and

training

responsibilities

The CPC's role in staffing and development is to maintain the integrityof the institutional credit approval system and the integrity and qualityof credit officers. In this capacity, the CPC:




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n Approves and reviews Senior Credit Officer and SeniorSecurities Officer appointments

n Ensures that approval authority is granted to skilled, highly

qualified individuals

MARKET RISK POLICY COMMITTEE (MRPC)

The Market Risk Policy Committee (MRPC) sets policies andstandards for market-focused risk identification, analysis, andmanagement. The MRPC is also responsible for overseeing the bank'smarket risk management activities. The Chairman of MRPC reports tothe Management Committee and Board of Directors.

General

responsibilities

The MRPC's responsibilities include, but are not limited to:

n Setting corporate policies and guidelines for market risk measurement, management, and reporting

n Confirming that market risk management processes (includingpeople, systems, operations, limits, and controls) satisfycorporate policies and are consistent with current technology

n Promoting a risk management environment that encourages andrequires the highest standards of ethical behavior by Risk Managers and transactors

n Reviewing and approving market risk limits, which implies activeinvolvement in the respective line business’ annual budget andplanning process

n Reviewing and approving any exceptions to policies codifiedin this manual

n Assisting (when necessary) in the development of new productprograms or market risk management programs

n Monitoring the timely and accurate reporting of exposures bybusinesses




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n Assisting in the development and implementation of ALCO

policies within respective countries

n Evaluating the magnitude, direction, and distribution of market

risks across the Corporation from a portfolio perspective

n Ensuring that the businesses provide for the ongoing validationof the adequacy and soundness of policies, assumptions,practices, and procedures. A Technical Advisory Sub-Committee(TASC) supports MRPC, acting as an institutional focal point onthe financial mathematics, valuation techniques, and computermodels

n Appointing Regional Treasurers and Country Treasurers

n Approving specified Exchange and Clearing House memberships

n Encouraging the professional development and training of staff engaged in market risk taking and market risk managementactivities

[Market Risk Policy Committee – Market Risk Standards, February, 1993]

Summary — Management Committee, CPC, MRPC

The risk management organization consists of the committeesthat establish policies, rules, and standards for the bank's risk management activities. The Management Committee establishes therisk culture and sets strategic risk targets for the bank. The CreditPolicy Committee defines the policies for credit risk, rules used incredit extension, and the general parameters within which LineManagement originates, approves, and manages credit risk. The MarketRisk Policy Committee establishes policies and standards

for identifying, managing, and reporting price and liquidity risk.




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In the next section, we will discuss the role of Line Management in therisk process. Line Management is the group that is responsible fordeveloping and implementing procedures that comply with the policiesand rules established by the committees.

LINE MANAGEMENT

Line Management is the group in the risk management organizationthat develops and executes business plans and initiates and approves allrisk positions. Line Managers are directly responsible and accountablefor:

n Initiating and managing risk

n Setting and achieving business goals

Credit Risk Management

Credit risk

management

responsibilities

Line Management is the core of Citibank's decentralized credit risk management system. The bank depends on Line Management to:

n Develop a business strategy, including target markets and risk acceptance criteria, in accordance with established policy andportfolio parameters

(Risk Acceptance Criteria [RAC or RAAC] is a set of characteristics used to define the type of risk the bank is willingto assume for each targeted industry and to identify potentialcustomers within an industry.)




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n Originate and maintain Credit Programs and Credit Transactionsin line with those parameters

(Credit Programs focus on the extension of credit to sets of

customers with similar characteristics and/or product needs.Credit Transactions focus on the extension of credit to anindividual customer or customer relationship.)

n Consult with CPC, when required, according to CCCP

n Report to the CPC as needed

n Identify an officer, known as "responsible officer," who hasprimary responsibility for each credit program or credittransaction

n Comply with all legal and regulatory requirements

n Ensure the timely creation of appropriate loss reserves

n Initiate identification and classification of problem credits andportfolios and implement remedial management efforts

n Implement recommendations for improvements fromManagement Committee, CPC, MRPC, or Business Risk Review

Portfolio management

responsibilities

A portfolio is an aggregate of transactions. A business must be awareof and manage trends and concentrations within its portfolio. Forexample, a portfolio may show a tendency to emphasize one or twoproducts or to concentrate activities in a specific industry,geographic area, or currency. These concentrations may or may notbe desirable and should be monitored carefully.

To manage a portfolio, Line Management is responsible for:

n Understanding the risk / return dynamics of each type of credit

risk in the portfolio

n Understanding the impact of changing business and economiccycles on a portfolio

n Obtaining sufficient data profiling for the portfolio




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n Performing standard, periodic portfolio reviews to monitorportfolio and process quality

n Correcting portfolio deficiencies as needed

Staffing and

development

responsibilities

Like CPC and MRPC, Line Management also has a role in staffing anddevelopment. Specifically, Line Management must:

n Determine the skill level necessary to undertake and managecredit risk proposed in the business plan

n Establish appropriate risk management policies and procedures

n Ensure highly qualified personnel through selection and training

n Nominate Senior Credit Officers, Senior Securities Officers,and other credit authority delegations

Line Managers and staff personnel with extensive training, experience,and market expertise may be designated as Senior Credit Officersand/or Senior Securities Officers.

S enior Credi t Of f i cers

Customer

expertsThe highest professional designation in the credit process at Citibank is that of a Senior Credit Officer (SCO). SCOs are customer expertswho are responsible for preserving the integrity of credit policiesand exercising balanced, independent credit judgment. They areappointed on the basis of their experience, abilities, and personalcharacteristics. Senior credit officers who have been granted LineManager SCO limits may provide final credit approval for amounts upto those limits. There are four levels of Line Manager SCOs.




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S enior S ecu r i t i es Off i cers

Expert in

underwriting

and distribution activities

Senior Securities Officers (SSO) are specialists who apply theirexperience and expertise to risk and process decisions for

underwriting and distribution activities. These capabilities haveevolved to their current level of sophistication in a relatively shortperiod of time and continue to evolve in a rapidly changing marketenvironment.

SSOs are appointed to preserve the integrity and manage the risk of Citibank's market practices in the underwriting and distribution toinvestors of corporate, money market, and government instruments.Their major responsibilities are to:

n Exercise independent judgment regarding the marketabilityof paper

n Approve specific counterparty risks

n Approve portfolio investment in equities / securities

Market Risk Management

Market risk is most effectively managed by professionals who haveclose, ongoing contact with customers, products, and markets. Themarket risk management process is consistent with Citibank's policyof decentralized line management with responsibilities for:

n Identifying price and liquidity risks associated with businessactivities

n Developing plans for measuring and managing those risks informal product programs

(Product programs identify and quantify price and liquidityrisks and describe the procedures and operating systems forcontrolling these risks.)

n Analyzing risk / return ratios




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n Avoiding undue concentrations

n Reporting to MRPC

This system of line management responsibility, together withcentralized reporting and controls, ensures that Citibank's policies,processes and systems adapt to the changing nature of market risks inan efficient and timely manner.

Summary — Line Management

Line Management develops and implements procedures to implementManagement Committee, CPC, and MRPC policiesand guidelines. Line Management is responsible for designingappropriate risk assessment tools, managing portfolios, and providingcompetent Senior Credit and Security Officers that are qualified tomonitor risk management procedures and make decisions based onexperience and sound judgment.

In the next section you will see how Business Risk Review provides anindependent evaluation of risk positions and risk management policiesand procedures.

BUSINESS RISK REVIEW (BRR)

The final group of Citibank's risk management organization is BusinessRisk Review. This group reports administratively to the Chairman of the Credit Policy Committee and reports functionallyto the Audit and Examining Committee of the Board of Directors. BBR

personnel are Line officers with a minimum of ten years of creditexperience. Senior officers may be invited to participate as guest

reviewers on the BRR team. As part of their risk management training,SCOs must participate in a review at least once every three years.




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Independent

evaluation of

business risk

management

Business Risk Review assesses portfolio risk and the risk management process from a business unit perspective. It provides anindependent evaluation of Citibank's business risk exposures and theadequacy of policies, practices, procedures, and reporting

mechanisms used to manage these risk positions.

Specifically, BRR is responsible for assessing the:

n Stated book value and the unit's capacity to absorb loss

n Compliance of all risk management practices, systems of internal control, and procedures with established policyand standards

These assessments may lead to recommendations for improvements inpolicies, practices, and procedures to be carried out by LineManagement, the CPC, the MRPC, and the Management Committee.

Portfolio Risk Assessment

The BRR determines the value and collectability of both direct andcontingent individual assets and also estimates the potential loss inrisk portfolios. To estimate loss, the BRR evaluates the:

n Adequacy of the loss forecasts established by line managementfor identified problems

n Capacity of the business to absorb unforeseen future losses

The five objectives for portfolio risk assessment are to:

1. Discover whether troubled positions in a portfolio have beenproperly identified by the line

2. Determine if adequate reserves / write-offs have been takenfor all troubled positions (BRR has the final say on individualclassifications)




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3. Quantify the risk level of the portfolio and compare it withline projections

4. Determine if Line Management has segmented the portfolio

where different risk levels or patterns can be identified

5. Assess whether Line Managers have adequately stress-tested theportfolio based on their forecast of possible adverse changes inthe market

Process Assessment

The BRR reviews the performance of each business unit against its risk

management standards and against institutional standards. Italso evaluates the risk management procedures developed byLine Management. Finally, it reviews the implementation of recommended improvements to the risk management process,related MIS systems, and to portfolio management.

Process assessments are conducted to assess the effectiveness of controls and to evaluate how risk exposures are created, managed, andeventually liquidated. This approach is based on the concepts that (1)any risk management process must be connected to an underlying

business flow and (2) in each risk management process there areidentifiable key risk factors.

UNIT SUMMARY

In this unit, we have identified the organizational groups involved inrisk management within Citibank. Management Committee sets thetone for risk management activities and the risk tolerance level for thebank. Credit Policy Committee and Market Risk Policy Committeeformulate the policies and rules which guide the risk managementprocess.




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Line Management develops procedures to implement the policies,rules, and standards from CPC and MRPC, and makes risk initiationand management decisions in the field.

Senior Credit Officers are ultimately responsible for credit risk andprocess decisions. Senior Securities Officers are responsible for risk and process decisions relative to underwriting and distributionactivities.

The Business Risk Review completes the risk managementorganization. It is responsible for reviewing the actions of LineManagement, ensuring that they are consistent and in line withcorporate policies and rules. The BRR may also recommend changesin policy to the CPC and MRPC.

You have completed Unit Two: Citibank's Risk Management Organization. Pleasecomplete the following Progress Check before continuing to Unit Three: Managing Credit

Risk in Citibank. If you answer any Progress Check question incorrectly, you should returnto the text and read that section again.




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þ PROGRESS CHECK 2

Directions: Select the correct answer for the following questions. There is only one correct

answer unless otherwise stated in the question. Check your answers with theAnswer Key on the next page. If you answer any of the questions incorrectly,return to the appropriate section of the text and review the material.

Question 1: These five organizational groups participate in Citibank's risk managementprocess:

____ a) Board of Directors, Corporate Division, Senior Credit Officers, SeniorSecurities Officers, and Line Management.

____ b) Risk Managers, Regional Treasurer, Business Risk Review, LineManagement, and Management Committee.

____ c) Management Committee, Credit Policy Committee, Market Risk PolicyCommittee, Line Management, Business Risk Review.

____ d) Market Risk Policy Committee, Corporate Division, Senior CreditOfficers, Business Risk Review, and Senior Securities Officers.

Question 2: Complete the statements below by providing the correct answer from the list:

Business Risk ReviewBoard of DirectorsCorporate DivisionMarket Risk Policy Committee

Senior Credit OfficersSenior Securities OfficersLine ManagementCredit Policy Committee

Risk ManagerManagement CommitteeRegional TreasurerCountry Credit Officer

________________________________ establish(es) the risk tolerance level forthe bank and sets the tone for risk management activities.

The____________________________ and the_____________________establish policies and rules for risk management.

___________________________________ is/are responsible for developingprocedures to implement policies and rules.

_____________________ review(s) and evaluate(s) policies, rules, and proceduresto ensure that portfolios are structured to achieve the corporation's goals.




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ANSWER KEY

Question 1: These five organizational groups participate in Citibank's risk managementprocess:

c) Management Committee, Credit Policy Committee, Market Risk

Policy Committee, Line Management, Business Risk Review.

Question 2: Complete the statements below by providing the correct answer from the list:

Business Risk ReviewBoard of DirectorsCorporate DivisionMarket Risk Policy Committee

Senior Credit OfficersSenior Securities OfficersLine ManagementCredit Policy Committee

Risk ManagerManagement CommitteeRegional TreasurerCountry Credit Officer

Management Committee establishes the risk tolerance level for the bank and setsthe tone for risk management activities.

The Credit Policy Committee and the Market Risk Policy Committee establishpolicies and rules for risk management.

Line Management is responsible for developing procedures to implement policiesand rules.

Business Risk Review reviews and evaluates policies, rules, and procedures toensure that portfolios are structured to achieve the corporation's goals.




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Question 3: Senior Credit Officers are appointed in order to:

____ a) preserve the integrity of the bank's credit policies and to exercisebalanced independent judgment.

____ b) conduct periodic portfolio reviews.

____ c) exercise independent judgment as to marketability of paper.

____ d) audit the bank's liquidity management.

Question 4: Select one responsibility of Senior Securities Officers.

____ a) The securitization of assets

____ b) Market risk associated with underwriting

____ c) Approving the inclusion of new names in the target market

____ d) Periodic portfolio reviews




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ANSWER KEY

Question 3: Senior Credit Officers are appointed in order to:

a) preserve the integrity of the bank's credit policies and to exercise

balanced independent judgment.

Question 4: Select one responsibility of Senior Securities Officers.

b) Market risk associated with underwriting




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Question 5: Listed below are some risk management duties. Next to each duty write theletter of the group that is primarily responsible for carrying it out.

a) Management Committee

b) Credit Policy Committee (CPC)

c) Market Risk Policy Committee (MRPC)

d) Line Management

e) Business Risk Review (BRR)

_____Report to the Board on large classified credits

_____Understand the impact of changing industry and economic cycles onthe portfolio

_____Manage the portfolio

_____Coach, train, and develop Credit Officers

_____Appoint Senior Credit Officers

_____Approve market risk limits

_____Set the tone for Citibank's risk management activities_____Ensure timely creation of appropriate reserves

_____Establish specific limits for certain higher risk portfolioconcentrations

_____Appoint Regional Treasurers

_____Decide how much risk the bank is willing to assume

_____Provide an independent evaluation of business risk exposures

_____Nominate SCOs and SSOs and provide other credit authoritydelegations




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ANSWER KEY

Question 5: Listed below are some risk management duties. Next to each duty write the

letter of the group that is mainly responsible for carrying it out.

a) Management Committee

b) Credit Policy Committee (CPC)

c) Market Risk Policy Committee (MRPC)

d) Line Management

e) Business Risk Review (BRR)

b Report to the Board on large classified credits

d Understand the impact of changing industry and economic cycles onthe portfolio

d Manage the portfolio

d Coach, train, and develop Credit Officers

b Appoint Senior Credit Officers

c Approve market risk limits

a Set the tone for Citibank's risk management activities

d Ensure timely creation of appropriate reserves

b Establish specific limits for certain higher risk portfolioconcentrations

c Appoint Regional Treasurers

a Decide how much risk the bank is willing to assume

e Provide an independent evaluation of business risk exposures

d Nominate SCOs and SSOs and provide other credit authoritydelegations



Unit 3





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UNIT 3: MANAGING CREDIT RISK

IN CITIBANK

INTRODUCTION

In Unit One, we defined the major categories of risk that are inherent in banking activities.We discussed Citibank's risk management organization in Unit Two and identified LineManagement as the group that is responsible and accountable for creating and managingrisk. The risks described in Unit One cannot be effectively managed in isolation; actions toreduce one type of risk can often increase another. As a Citibanker, it is important for youto understand the credit risk management process and how your own responsibilities mightcontribute to the bank's portfolio and risk management goals.

In this unit, we will focus on the credit process and those elements that address portfoliomanagement.

UNIT OBJECTIVES


n Identify the three phases of the credit process as defined by Core CreditPolicies

n Define the activities associated with each phase

n Recognize the key risks of the Business Risk Review audit process

n Identify the four objectives of portfolio management

n Recognize the risk ratings assigned to facilities and customers

Recognize the return-on-risk objective for credit extensions



3-2 MANAGING CREDIT RISK IN CITIBANK

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OVERVIEW OF THE CREDIT PROCESS

The diversity of customers, products, and business strategies atCitibank requires that we have a well-defined, integrated creditstructure. This "credit architecture" includes clearly stated policies andprocedures for managing credit, the necessary tools and informationflows to make decisions, and people who share core values, a commonvocabulary, and a conceptual understanding of their roles in the creditprocess. When these elements are thoughtfully integrated, they createan efficient and effective credit culture.

Credit Management Model

Individual and

commercial

customer

constituencies

Citibank's organization and credit activities are built around two basiccustomer constituencies: individuals and commercial enterprises. Wewill focus on the commercial credit model, whichis geared toward lower transaction volume, larger transaction size, andcustomized products that require a judgmental process for originating,approving, and maintaining transactions. The goalsof an efficient and effective credit process are to:

n Ensure that the bank achieves targeted risk-adjusted financialresults with a high degree of reliability

n Minimize losses consistent with targeted returns and ourtolerance for risk and risk appetite

Three phases

of the credit

process

To manage the credit process with predictable results, we mustunderstand the dynamic and interactive nature of each phase of thecredit process. The three phases, as defined in Citibank Core CreditPolicies, are:

I. Portfolio Strategy and Planning

Define desired financial results and the strategies required toachieve them.



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II. Credit Origination and Maintenance

Create and maintain transactions and portfolios withcharacteristics that are consistent with our strategies.

III. Performance Assessment and Reporting

Monitor our performance for continual improvement.

Responsibilities Each group that participates in the credit process has well-definedresponsibilities.

Management Committee

• Establishes performance objectives and portfolio

composition criteria for the bank

• Sets concentration limits with Credit PolicyCommittee

Credit Policy Committee

• Sets concentration limits with Management Committee

• Develops credit policies

• Monitors and assesses portfolio and portfoliomanagement process

Line Management

• Establishes a business strategy

• Defines target market and risk acceptance criteria

• Solicits customers and evaluates risk

• Approves risk exposures

• Handles disbursement and documentation of credits

• Monitors and maintains credit transactions




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• Distributes to investors

• Monitors performance of credits, problemindentification, and remedial management

• Monitors and assesses portfolio and portfoliomanagement process

• Provides effective organizational structure

• Promotes performance quality

In the next sections, we will look at each phase of the credit process.

PHASE I: PORTFOLIO STRATEGY AND PLANNING

Objectives Portfolio strategy and planning activities are an integral part of theannual planning process for each business. The objectives of this phaseof the credit process are to define:

n Desired risk-adjusted financial results for each businessand for the bank as a whole

n Credit standards required to achieve them

In Phase I, the Management Committee sets performance objectivesand establishes criteria for developing portfolios to achieve theobjectives. The Credit Policy Committee and the ManagementCommittee approve portfolio concentration limits. Credit PolicyCommittee develops policies for the extension of credit and LineManagement develops an overall business strategy, defines targetmarkets, and establishes risk acceptance criteria.




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Concentration Limits

The Credit Policy Committee and the Management Committeeapprove portfolio concentration limits based on the bank's overall risk

capacity, capital considerations, and evaluation of internal and externalenvironments. By setting and adhering to limits, businesses in Citibank avoid concentrations that can result from seemingly unrelatedactivities and ensure that none of the asset categories or risk dimensions can harm the overall performance of the bank.

Limits for

different risk

dimensions

Group Executive Vice-presidents, with approval of the Credit PolicyCommittee, set specific concentration limits to control Citibank'sexposure to different portfolio risk dimensions. Concentration limitsmust be set for at least the following risk factors:

n Customer

n Industry

In addition, limits may be set for other factors, such as:

n Geography

n Equities and subordinate debt

n Product

n Highly leveraged transactions

n Risk rating

The Management Committee and the Chairman of the Credit PolicyCommittee may set aggregate concentration limits at the corporatelevel and adjust line business limits accordingly. Line Managers mustmonitor and report outstandings by each factor and ensure thatportfolios under their responsibility are kept within the approvedlimits.




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Credit Policies

Balance earnings

objective with

customer needs

Our goal is to achieve our risk-adjusted earnings objective and satisfyour customers' needs while maintaining a sound credit portfolio.

Credit policies help us to achieve this balance. Credit policiesinclude:

Policies that define appropriate behavior.

Standards or

performance

criteria

by which behavior can be measured forcompliance with policies and objectives.

Procedures that define specific activities to ensurethat standards are met.

Credit policies are constant. They define credit management issuesfrom a strategic perspective. Credit procedures have a tacticalperspective and change as frequently as our business changes. Wemust re-examine procedures frequently to ensure that they conform topolicies.

Business Strategy

Plan for meeting

targeted

earnings

objective

Citibank's objective is to build strong customer relationships anddiversified product portfolios. We target industry sectors in which wecan achieve a strong market position and adequate returns on capital.Each business charts a course for achieving a targeted risk-adjustedearnings objective and designs products to translate a risk-consciousbusiness strategy into terms and conditions that control risk.




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Strategic business planning begins with an assessment of external andinternal factors. Important external environmental factors include:

n Global, national, and local economic trends

n Current social, political, legislative, and demographic forcesof change

n Legal and regulatory context

n Perception of Citibank's business by financial markets and rating / regulatory agencies

The business planning process must also consider internal factors,

such as:

n Staff availability and skill relative to business risks andopportunities

n Quality and composition of our portfolio

n The bank's capital position relative to the business risks

n Adequacy of the managerial, technological, and operationalinfrastructure

Target Market and Risk Acceptance Criteria

Target market

analysis:

customer profile

A target market definition identifies the acceptable profile of customers and the products we will offer them. A target marketanalysis includes:

n Identifying potential markets (geographic, industry, product, etc.)based on a review of all participants in each market

n Defining opportunities within those markets




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n Continuously monitoring the business climate, evaluating thebank's position in each market, and adjusting the target marketcriteria accordingly

n Describing quantitative and qualitative factors of target clients ineach market

Risk acceptance

criteria:

screening

tools

Risk acceptance criteria are the terms and conditions for selectingcustomers within the target market. Once a business has developeda business strategy and identified a target market, it must establishscreening tools to ensure that individual exposures and the overallportfolio are consistent with business objectives. A business identifiesspecific accounts that fit its risk acceptance criteria. The criteria mayinclude such indicators as:

n Level of sales

n Management quality

n Growth potential

n Relationship with government

n Position within the industry sector

n Financial parameters

n Suitable credit terms

n Earnings potential for the bank

Line Management Responsibility

Line Management establishes and approves a business strategy, based ona clearly defined target market, comprehensive risk acceptance criteria,

minimum profitability standards, and appropriate concentration limitsthat match the characteristics of the portfolio to the risk capacity of thebank. Line Managers are also responsible for planning for the resourcesneeded to manage existing business and risks.




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PHASE II: CREDIT ORIGINATION AND MAINTENANCE

In the "credit origination and maintenance" phase, Line Managementsolicits, evaluates, approves, and manages credit exposures according

to the strategies and portfolio parameters established in Phase I.Underwriting for distribution to investors takes place in the secondphase of the credit process.

Origination

Generating a

transaction

Origination refers to the process of soliciting a customer, respondingto customer requests, evaluating risk, and setting up a transaction.Transactions are generated within the guidelines of well-defined target

market criteria, product configurations, and risk acceptance criteria(RAC). They are evaluated relative to our RAC and other requirementsand policies, and approval requirements are determined by a credit'srisk rating. (Risk ratings are discussed later in the PortfolioManagement section of this unit.)

Evaluation

Qualifying

potential customers

An analysis of a company is initiated to determine if the company

qualifies as a potential customer. Information sources includemanagement within the company and third parties such as other banks,the market, and credit agency reports. Evaluation of a borrower'screditworthiness focuses on the five Cs of credit: character, capacity,cash flow, collateral, and capital.

A background check of a customer is conducted to assess:

n Character

n Operations

n Management

n Strategy




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n Industry as a whole

n Competitors of the company

n Prevailing business conditions

The bank checks the capacity of the customer to generate enough cashflow to fulfill its obligations to the bank as well as its other financialobligations. Financial evaluation includes an analysis of the:

n Value of the customer's cash flow

n Capital

n Collateral

An analysis of a client's financial statement (audited, if possible),client visits / interviews, a loan structure summary, and a completedreport or check list are important elements of the evaluation process.

Approval

Credit approval is granted on an individual transaction basis or for adefined set of customers. Both objective criteria and good judgmentare required to make sound decisions for accepting or rejectingbusiness.

Three-initial

credit approval

system

Citibank uses a three-initial credit approval system and names aresponsible officer for each transaction. A transaction may alsorequire the approval of other parties, such as business or industryspecialists or legal counsel. The approving parties are responsible forverifying that:

n The information in the credit analysis addresses both risksand opportunities

n The structure of the transaction is based on identified risksand protects the bank against them and other creditors




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n A process is in place for remedial management action, if needed

n Loan structures are consistent with financing purpose andthe borrower's cash flow patterns

n Target market criteria are met

Risk Summary Reports (RSRs) summarizing our facilities must beprepared for large transactions or clients with large aggregateexposures in order to inform our Board of Directors.

Monitoring and Maintenance

There are two possible conclusions for any credit transaction:

1. Orderly reduction and the eventual end of the risk exposure

2. A workout phase, which consists of intensive collectionefforts until there is finally a full or partial repayment

Normal risk

management

Once a credit transaction has been approved, processes must be inplace for monitoring the risk exposure and maintaining it at anacceptable level. Normal risk management includes:

n Controlling documentation and disbursement

n Monitoring timely repayment

n Controlling and valuing collateral

n Reviewing the status of an exposure

By carefully monitoring individual credit transactions, we can

recognize troubled exposure as soon as symptoms appear. Theearlier a problem is detected, the more options a manager has forimplementing remedial management techniques to maximizerepayments and minimize losses.




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Problem Recogni t ion

Keys to

managing

troubled exposures

Anticipation, early detection, and timely reporting of potentialproblems are the keys to identifying and managing troubled exposures

successfully. The objective is to recognize problems / weaknesseswhile adequate alternatives for action exist.

Individual responsibilities for monitoring the risk exposure must beclearly defined. To anticipate problems, we ask "What if . . .?"questions when reviewing portfolios, writing call memos, andconducting credit reviews. In most problem accounts, classified creditreviews are generated on a regular basis. These reports contain keyperformance indicators, including:

n Past due obligations

n Incomplete customer legal documentation, if any

n Loan recovery strategy

n Liability MIS, which would include information about the totalamount of transactions by customer, industry sector, currency,tenor, etc.

Classified credit

process

The commercial credit model uses a judgmental process for classifyingcredits. There are five classification categories: one category for soundcredit exposures and four categories of adverse classification indicatingincreasing degrees of potential risk of loss. The purpose of theclassified credit process is to establish a consistent approach toproblem recognition, labeling, remediation, and the setting of reservesfor credit exposures that are managed on a judgmental basis. Theprocess is designed to:

n Highlight problem credits for attention and action

n Categorize problems by severity of actual and potential risk of loss




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n Report problem credits to senior management for review andapproval at intervals that are set according to the severity of theclassification

n Provide a common language and methodology across divisionsand countries for identifying and managing problem credits

To properly classify a problem credit, a manager must be able to:

n Differentiate between symptoms and their causes

n Assess the borrower's ability to correct the problem within areasonable amount of time

n Consider the options available to the bank to improve its positionas a creditor

R e m e d i a l Ma n a g e m e n t

Objective is to

minimize loss

The objective of remedial management is to minimize losses thatcould result from problem credits. Early intervention may preventa potential loss from becoming an actual loss.

Remedial management begins with a problem-solving strategy thatdefines alternative courses of action and specific deadlines. Theseplans must be documented in Classified Credit Reviews (CCRs).

A classified credit may continue to be handled by the unit thatmanaged the credit while it was classified as current, or it may betransferred to a "workout unit." The responsible officer will assess theextent of the problem, implement tracking strategies, analyze andcreate restructurings, reevaluate strategies as situations change, andredocument new/existing structure as necessary.




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An important part of remedial management is to assess theeffectiveness of remedial action for classified credits and for creditprocess problems. The assessment is fed back through the strategicplanning process to improve the business strategy and the risk

origination process.

Citibank's Credit Classification System (pages 3-15 and 3-16) showsthe classifications that may be assigned to a credit, the definition of each classification, and some of the characteristics used to determinethe classification.




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CITIBANK’S CREDIT CLASSIFICATION SYSTEM

CategoryClassification Definition Characteristics

I Current No evident weakness Obligations, or portions of obligations, for which interestand principal payments are fully up to date, and orderly

repayment and/or timely settlement in the future is

without doubt.

IA (Other Assets

Especially

Mentioned)

Credits show evidence of

weakness in borrower’s

financial condition or credit

worthiness;

Credits may be subject to

unrealistic repayment

program; lacking adequate

collateral, creditinformation, or

documentation.

+ Environmental / operational indicators:

− clear evidence of adverse changes

− absence of controls (frequent accidents; messy

inventory)

− labor problems

− lack of management depth / key management

departures

− cash draining subsidiaries

− over-reliance on single product / supplier / customer− products subject to intense competition or

technological obsolescence

− over-reliance on imports / exports, or certain types

of currencies with strong devaluation risks

− adverse regulatory, political, economic environment

+ Financial performance indicators:

− adverse trend in sales and earnings

− profit margin erosion

− interim losses

− fixed-price contracts in highly inflationary

environment

+ Balance sheet deterioration indicators:− leverage relative to the company’s past; its plan,

and industry norms

− receivables or inventory excesses

− trade payable slowness

+ Transactional indicators:

− no seasonal clean-up; lingering overdraft excesses

− term loan covenant violations (indicated by waivers,

amendments)

− long-term needs financed with short-term facilities

− unrealistic repayment schedule

− diversion of loan proceeds to other than stated use

− absence of adequate collateral where needed




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CITIBANK’S CREDIT CLASSIFICATION SYSTEM

CategoryClassification Definition Characteristics

IA (Other AssetsEspecially

Mentioned)

(Continued)

+ Other indicators:− failed syndication or sell-down, reflecting market

assessment

− weak operational or financial controls and internal

MIS

− inadequate or outdated financial data

− qualified auditor’s opinion

− significant litigation

− material adverse change vis-a-vis the rationale for

original risk decision

II (Substandard) Normal repayment of

principal and interest may

be or has been jeopardized;

No loss is yet foreseen,

but protracted workout

period is possible.

+ Indicators are the same as for IA, but in a more

aggravated situation;

+ Other indicators:

− credit line frozen due to political pressure, legal

action, etc.

− bank locked in due to lack of alternative funding

sources

− ineffective creditor coordination

− assets may be pledged to third parties

− debt restructuring required

− bankruptcy, foreclosure, forced liquidation

III (Doubtful) Full payment appears

questionable on basis of

current information;

Certain degree of loss, as

yet undetermined, is

possible.

+ Key indicator here is the prospect of loss.

Characteristics are more adverse than IA and II.

+ Other indicators:− auditor’s disclaimer of opinion or a qualification as

to continued viability of company

− uncertain collateral coverage

− negative net worth and working capital

− trade credit frozen

− full recovery dependent on unlikely events

− ineffectiveness of borrowers’ or creditors’ remedial

efforts

− consistent failure to meet commitments

− principal or interest past due 90 days

IV (Loss) Credit is regarded asuncollectable.

The amount of loss can be determined by:+ quantifying the shortfall between collateral and amount

owed.

+ build-up of claims and litigation that will limit the

amount the bank could recover.




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Distribution to Investors

Loans are remarketed to third parties (mainly to other banks) for anumber of reasons. It allows the bank to generate revenues from the

distribution process. It also provides clients with access to differentfunding sources and with the potential for acquiring more funds thanwe may be prepared to provide ourselves. Additionally, this enables usto more effectively monitor and control the composition of the bank'sportfolio.

Remarketing

transactions to

third parties

Origination and underwriting for distribution to investors also takeplace in the second phase of the credit process. The same standardsapply when assets are originated for sale to third parties as when theyare originated for our own books, but they are applied from the point

of view of remarketing a transaction to another investor.

A market analysis is done to understand current market conditions, themarket demand for a particular asset, and the types of investors whowould buy the asset. If portfolios and balance sheets are managedeffectively, assets are placed in the market on a timely basis and soldat favorable prices. By conducting an intensive evaluation of possiblepurchasers, the bank is positioned to take advantage of opportunitieswhen the time is right.

Agent for

transaction

After placing an asset with third party investors, the bank may act as anagent by performing contractually defined tasks to facilitate thetransfer of information and/or money between the issuers and theinvestors. To maintain portfolio quality and reputation, syndicatedloans must be managed with the same attention and care as held assets.




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Summary — Phases I and Phase II

Phases I and II may best be summarized as the planning andimplementation phases of the credit process. In the "portfolio planning

and strategy" phase, the Management Committee and Credit PolicyCommittee establish performance objectives, portfolio criteria,concentration limits, and credit policies. Line Management setsbusiness strategies and defines target markets and criteria for risk exposures.

In the "credit origination and maintenance phase," Line Management isresponsible for managing prospects and customers, evaluating the risk associated with each customer and facility, initiating / approving creditprograms / transactions, and documenting / disbursing credit.

Transaction monitoring and maintenance in both normal and remedialmodes and timely distribution to investors are essential for achievingthe objectives of the credit process: to minimize losses and achievetargeted financial results.

Phase Three is dedicated to assessing the portfolio and the creditprocess. We ask the questions:

n "How well did we do?"

n "What can we do to improve?"

The information is fed back to the Management Committee, CreditPolicy Committee, and Line Management — and the process beginsagain. Let's look at the activities that occur in Phase III.




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PHASE III: PERFORMANCE ASSESSMENT AND REPORTING

Portfolio Monitoring

Assess portfolio

and adjust

process

Senior Managers and Line Managers continually monitor the portfolioto improve portfolio performance. They track portfolio and processtrends and make appropriate and timely adjustments to businessstrategies, portfolio parameters, credit policies, and credit originationand maintenance practices.

During this phase of the credit process, we use internal informationand external benchmarks to help evaluate portfolio performance.The information derived from the evaluation is a critical corporateresource that provides a link between all three phases of the creditprocess. The following dimensions must be recorded, monitored, andreported for each credit risk:

Re l a t i onsh i p

n Name of parent company

n Parent company standard customer code

Custom er (Obl igor)

n Name of subsidiary

n Subsidiary standard customer code

n Business segment

n Seasoning (age of credit relationship)

n Industry (Standard Industrial Code — SIC)

n Customer risk rating




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Fac i l i t y

n Amount of facility and outstandings

n Extending and approving units

n Product type

n Direct, contingent, pre-settlement

n Committed / uncommitted

n Tenor

n Collateral type

n Liquidity

n Adverse classification

n Prior write-offs and write-downs

n Performing (accrual) status

n Facility risk rating

This information must be aggregated for all credits in the group,division, or country as needed to prepare summary profile data or

reports on the unit's total portfolio. This data is used to monitor theportfolio against concentration limits and other established portfolioobjectives.




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BRR Portfolio and Process Reviews

Independent

review by BRR

The credit performance of Line Management is subject to independentreview by Business Risk Review (BRR). BRR examines the portfolio

management system of each business to analyze portfolio risk positions.It assesses the value and collectability of direct and contingent assets andevaluates the potential for loss. This information is used to answer thefollowing two questions:

n Are line loss forecasts enough to cover any identified problems?

n How much of a loss can the business absorb if unforeseenproblems occur?

Five components

of BRR business

flow

For BRR credit review purposes, the credit risk management process isorganized as a business flow consisting of five components:

I. Business Strategy, Staffing and Organization

II. Risk Origination and Structuring

III. Structuring and Distribution

IV. Transaction Monitoring, Maintenance, and Collection

V. Portfolio Management

The line organization is required to establish specific managementprocesses for properly executing certain activities in each of thesebusiness flows. BRR focuses on each activity as a key risk factor,reviewing the quality and adequacy of the risk management process.Let's look at this checklist and the review objective for each factor.




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I. Business Strategy, Staffing, and Organization

Risk Factors Review Objectives

Ρ Target Market Ensure that the rationale and process for atarget market strategy and adherence isappropriate for a given environment.

Ρ Risk Acceptance

Criteria (RAC)

Ensure that the selection of specific RACs isconsistent with business strategies and targetmarkets and appropriate for a givenenvironment.

Ρ Staffing and

Organization

Evaluate (1) staffing adequacy and continuity,(2) organization and placement, and (3)coaching and training.



Ρ Evaluation Evaluate the quality of risk origination, theadequacy of the recommendation process forrisk extensions, and the appropriateness ofthe transaction structure.

Ρ Compliance Evaluate the business' process for ensuringconformance to legal, tax, accounting,regulatory, ethical, and disclosurerequirements.

Ρ Valuation Assess the business' valuations of acustomer's cash flow and financialperformance, collateral, support, andguarantees.

Ρ Approval Evaluate the approval process for riskinitiations, particularly with respect toaccountability.

Ρ Documentation Evaluate the adequacy of documentation andthe process by which the adequacy ofdocumentation is ensured.




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Ρ Underwriting Analysis

Determine that exposures booked for sale areoriginated under the same standards thatapply for held assets. Verify that distributiondepartments effectively assess marketconditions and advise originators accordingly.

Ρ Sales and

Trading

Determine that sales occur as expected andthat the business effectively coordinates withrelevant departments.

Ρ Agency Ensure that syndicated loans are managedwith the same attention as held assets andthat agent responsibilities are discharged.



Ρ Risk

Administration

Verify that the business' procedures and MISreports are adequate to manage credit risks.

Ρ Problem

Recognition

Assess the business' effectiveness in recognizingproblem portfolio trends in a timely manner.Evaluate Line Managers' ability to recognizeindividual credit problems, appropriately reclassifycredits or adjust risk ratings, and contain orresolve issues.

Ρ Remedial

Management

Determine the effectiveness of remedial action forclassified credits and for credit processproblems.




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Ρ Data Integrity Determine that the business has accuratelyidentified the risk dimensions of its portfoliothrough proper risk ratings and classifications.Evaluate the process for timely updates ofportfolio information.

Ρ Portfolio Policy

and Strategy

Assess adequacy of the tools used to monitorportfolios.

Business Risk Review documents its findings in action-oriented

reports to Line Management, Senior Management, and the Board of Directors. These reports supply the information that is needed forupdating and improving the credit process at Citibank. BRR providesone integrated rating to the Line Management that indicates its level of concern regarding the current performance of the entire portfolio orany relevant subsegments and concerns about the portfolio's futureperformance.

Summary

Figure 3.1 on the next page is a model of the three phases of the creditprocess as presented in Citibank Core Credit Policies. The modelpresents the functions that occur in each phase and the risk organization group that is responsible for each function.




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The comparison table in Figure 3.2 shows the relationship between thethree-phased credit process and the five components of the businessflow used by BRR in its review process. You can see that Phase I of thecredit process involves managing the key risk factors identified as part

of BRR's "Business Strategy, Staffing, and Organization" business flow.Phase II of the credit process relatesto the second, third, and fourth business flows. Finally, Phase IIIrelates to the key risk factors of BRR's "Portfolio Management"business flow.

The goal of an effective and efficient credit process is to ensure thatwe achieve targeted financial results. To manage the credit process forpredictable results, we must understand the dynamics and interactivenature of these phases. We must define desired financial results and

the strategies to achieve them, create transactions and portfoliosconsistent with our strategies, and then monitor our performance toprovide information for continual improvement.




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Figure 3.1: The three phases of the credit process

Conduct independent

reviews of portfolio

and rocess.

Monitor and assess

portfolio and process.

Remidial

management

Normal

management

Distribute to investors.Monitor and maintain credit.

Approve using:

+ Credit Program

+ Credit Transaction

Solicit customer

and evaluate risk.

Set business strategy.

Define target market

and risk acceptance

criteria (RAC).

Set concentration limits

and develop credit

policies.

Set performance

objectives and portfolio

com osition criteria.

III. Performance

Assessment

and Reporting

II. Credit Origination

and Maintenance

Feedback on strategy, policies, and process

I. Portfolio Strategyand Planning

Credit Policy Committee Management Committee

Line Management

Line

Management

Line Management

Line Management

Line Management and CPC Business Risk Review (BRR)

Line Management




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CORE CREDIT POLICYThree Phases of the Credit Process

BUSINESS RISK REVIEWFive Business Flow Components

I. Portfolio Strategy and Planning I. Business Strategy, Staffing, and

Organization

+ Target Market

+ Risk Acceptance Criteria

+ Staffing and Organization

II. Credit Origination and Maintenance II. Risk Origination and Structuring

+ Evaluation

+ Compliance

+ Valuation

+ Approval

+ Documentation


+ Underwriting Analysis

+ Sales and Trading

+ Agency

IV. Transaction Monitoring, Maintenance,

and Collection

+ Risk Administration

+ Problem Recognition

+ Remedial Management

III. Performance Assessment and Reporting V. Portfolio Management

+ Data Integrity

+ Portfolio Policy and Strategy

Figure 3.2: Relationship between Credit Process and BRR Business Flow

You have completed the section on the Credit Process. Please proceed to Progress Check

3.1 and answer the questions to check your understanding of the material. Then, continuewith the next section, "Portfolio Management."




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þ PROGRESS CHECK 3.1

Directions: Select the correct answer for the following questions. There is only one correct

answer unless otherwise stated in the question. Check your answers with theAnswer Key on the next page. If you answer any of the questions incorrectly,return to the appropriate section of the text and review the material.

Question 1: The three phases of the credit process may be summarized as:

____ a) origination, management, and distribution.

____ b) planning, problem recognition, remedial management.

____ c) planning, implementation, and assessment.

____ d) origination, collection or remedial management, and evaluation.

Question 2: Select two objectives of Phase I of the credit process.

____ a) Originate transactions with newly targeted customers.

____ b) Monitor credits and isolate potential problems for remedial action.

____ c) Define desired risk-adjusted financial results for each business and for

the bank as a whole.

____ d) Approve risk exposures for distribution to investors.

____ e) Define credit standards to achieve desired financial results.

Question 3: Concentration limits must be set for at least the following portfolio risk dimensions:

____ a) Industry, geography, management, earnings, and risk factors

____ b) Customer, industry, geography, product, and risk ratings

____ c) Customer, business sector, earnings, and product programs

____ d) Target market, business sector, earnings, and risk ratings




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ANSWER KEY

Question 1: The three phases of the credit process may be summarized as:

c) planning, implementation, and assessment.

Question 2: Select two objectives of Phase I of the credit process.

c) Define desired risk-adjusted financial results for each business and

for the bank as a whole.

e) Define credit standards to achieve desired financial results.

Question 3: Concentration limits must be set for at least the following portfolio risk dimensions:

b) Customer, industry, geography, product, and risk ratings




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PROGRESS CHECK 3.1(Continued)

Question 4: Select three components of credit policies.

____ a) Policies

____ b) Standards

____ c) Limits

____ d) Customer profiles

____ e) Procedures

Question 5: The "credit origination and maintenance" phase includes many activities.Identify the category that applies to each of the following activities by writing

the letter of the category next to the activity.

Categories: O = Origination M = Monitoring and maintenance A = ApprovalE = Evaluation D = Distribution

Activities:

____ Assessment of key internal and external factors that may affect thecustomer's business

____ Assessing the value of a customer's collateral

____ Soliciting a customer

____ Timely intervention to minimize losses____ Remarketing a transaction to a third party

____ Preparing the loan contract

____ Applying the three-initial system

____ Early detection of problem credits

____ Disposing of assets at favorable prices

____ Analyzing the customer's management team

____ Appointing a responsible officer

____ Assessing the company's future cash flows

____ Understanding the customer's business strategy

____ Classifying problem credits




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ANSWER KEY

Question 4: Select three components of credit policies.

a) Policies

b) Standards

e) Procedures

Question 5: The "credit origination and maintenance" phase includes many activities.Identify the category that applies to each of the following activities by writingthe letter of the category next to the activity.

Categories: O = Origination M = Monitoring and maintenance A = ApprovalE = Evaluation D = Distribution

Activities:

E Assessment of key internal and external factors that may affect thecustomer's business

E Assessing the value of a customer's collateral

O Soliciting a customer

M Timely intervention to minimize losses

D Remarketing a transaction to a third party

O Preparing the loan contract

A Applying the three-initial system

M Early detection of problem credits

D Disposing of assets at favorable prices

E Analyzing the customer's management team

A Appointing a responsible officer

E Assessing the company's future cash flows

E Understanding the customer's business strategy

M Classifying problem credits




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Question 6: Mark the following statements true (T) or false (F).

____ a) Different standards apply when assets are originated for sale to thirdparties than when they are held assets.

____ b) Most of the distribution group's customers are investors.

____ c) By conducting a target market analysis of potential purchasers, the bank ispositioned for timely pursuit of underwriting opportunities.

____ d) Syndicated loans must be managed with the same careful attention as held

assets.

Question 7: Select the key performance indicators that are periodically reported forproblem accounts:

____ Credit file maintenance process

____ Past due obligations

____ Problem credit classification

____ Loan recovery strategy

____ Customer cash flow

____ Incomplete customer legal documentation

____ Total amount of transactions by customer, sector, currency, and tenor




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ANSWER KEY

Question 6: Mark the following statements true (T) or false (F).

F a) Different standards apply when assets are originated for sale to thirdparties than when they are held assets.

T b) Most of the distribution group's customers are investors.

T c) By conducting a target market analysis of potential purchasers, the bank ispositioned for timely pursuit of underwriting opportunities.

T d) Syndicated loans must be managed with the same careful attention as held

assets.

Question 7: Select the key performance indicators that are periodically reported forproblem accounts:

Past due obligations

Loan recovery strategy

Incomplete customer legal documentation

Total amount of transactions by customer, sector, currency, and tenor




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Question 8: To handle problem accounts, management may assign a special task force,which is called:

____ a) a "workout unit."

____ b) a "credit remediation group."

____ c) "Task Force One."

____ d) a "negotiation team."

Question 9: Identify three applications of the credit classification system.

____ a) Rank the portfolio from most risky to less risky assets.

____ b) Categorize credits by severity of actual and potential loss.

____ c) Classify loans by industry sector.

____ d) Support the timely update of the target market analysis.

____ e) Highlight problem credits for attention and action.

____ f) Apply a common language and method to problem loan identification andmanagement.

Question 10: Select three objectives of the BRR evaluation process.

____ a) Assess the value and collectability of direct and contingent assets.

____ b) Assess target market selections.

____ c) Evaluate management performance.

____ d) Analyze portfolio risk positions.

____ e) Evaluate potential for loss.

____ f) Analyze business unit balance sheets.




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ANSWER KEY

Question 8: To handle problem accounts, management may assign a special task force,which is called:

a) a "workout unit."

Question 9: Identify three applications of the problem classification system.

b) Categorize credits by severity of actual and potential loss.

e) Highlight problem credits for attention and action.

f) Apply a common language and method to problem loan

identification and management.

Question 10: Select three objectives of the BRR evaluation process.

a) Assess the value and collectability of direct and contingent assets.

d) Analyze portfolio risk positions.

e) Evaluate potential for loss.




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Question 11: Match each of the five components of BRR's business flow with itscorresponding key risk factors:






EvaluationComplianceValuationApprovalDocumentation

Portfolio StrategyData Integrity

Risk AdministrationProblem Recognition

Remedial Management

Underwriting AnalysisSales and TradingAgency

Target MarketRisk Acceptance CriteriaOrganization and Staffing




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ANSWER KEY

Question 11: Match each of the five components of BRR's business flow with itscorresponding key risk factors:






II EvaluationComplianceValuationApprovalDocumentation

V Portfolio StrategyData Integrity

IV Risk AdministrationProblem Recognition

Remedial Management

III Underwriting AnalysisSales and TradingAgency

I Target MarketRisk Acceptance CriteriaOrganization and Staffing




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PORTFOLIO MANAGEMENT

Limit risk;

build in

flexibility

and liquidity

The composition of the bank's portfolio is managed by limitingconcentrations of risk and building in flexibility and liquidity. Aportfolio management system allows the Management Committeeto identify and control the size and mix of the bank's portfolio whiledecentralizing to Line Management, in conjunction with the CreditPolicy Committee, responsibility for credit origination andmaintenance.

Line Management in each group is responsible for developing,implementing, and maintaining a comprehensive portfolio

management system that reflects the diversity of the business withinCitibank. Each group develops its own detailed policies based on thebroad policies in Citibank Core Credit Policies.

Although the installation, management, periodic review, and approvalof portfolio management elements are the responsibility of theManagement Committee, some elements require the support andinvolvement of the Credit Policy Committee to ensure consistencyand comparability across the bank. These elements include:

n Debt-rating models or other processes used to assign risk ratings

n Credit loss forecasting methodology

n Portfolio profile guidelines and concentration limits




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Objectives of a Portfolio Management System

An effective portfolio management system is more important intoday's banking environment than ever before due to rapid changes in

Citibank's client base and the need to identify, monitor, and control themix of investment / non-investment grade paper. There are four mainobjectives of portfolio management.

1) Achieve risk-adjusted returns on capital consistent withcorporate objectives and risk tolerance.

2) Provide a framework for origination activities within theconcentration limits set by Senior Management.

3) Evaluate the acceptability of potential losses based on currentrisk profiles and projected alternative scenarios.

4) Understand and communicate the risk profile and otherdimensions of a portfolio.

Risk Ratings

Common

language for

comparing

credit exposures

In addition to the Credit Classification System, which you saw inthe last section, a risk rating scale is another important tool for

managing the bank's portfolio. Risk ratings are intended to providea common language that enables us to describe and compare allCitibank credit exposures, regardless of the nature, type, or location of the credit facility.

Risk ratings are assigned to customers and facilities on a scale of 1 to10. The best rating is a 1, which generally corresponds to a "AAA"investment grade on the Standard & Poor rating scale. A customer orfacility with this rating is regarded as close to risk-free. A risk ratingof 10 generally corresponds to Standard & Poor's "D" rating and

indicates that a customer or facility is "doubtful" or a "loss." Ratings of 1 to 4 are regarded as investment-grade ratings, while 5 to 10 are non-investment grade. Citibank risk ratings are defined in terms of "loss

norms."




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Loss Norms

Probability of

default multiplied

by potential loss

The assignment of a risk rating is a statement that a customer andfacility display similar characteristics to other customers and facilities

which have, on average over a period of time, produced a present valueloss equal to a certain loss norm or within a range of loss norms. Theloss norm is not a prediction that there will be an actual loss. Itrepresents the probability of default within the next 12 months,expressed as a percentage, multiplied by the economic loss in theevent of default (LIED), also expressed as a percentage. The resultingloss norm is expressed in basis points and represents the present valueof the total cost of credit from the date of default through the life of the problem workout, a period which can be several years.

On pages 3-42 through 3-44, you can see a comparison of Standard &Poor's (S&P) debt ratings and Citibank's risk ratings. Each Citibank risk rating is listed with the corresponding S&P rating, a definition of the rating, and some characteristics of companies that may be assignedeach rating. Keep in mind that loss norms are the only formaldefinition of Citibank's ratings; the S&P ratings are shown only as acomparison to help with an understanding.

Our business environment is constantly changing and, therefore, theseprofiles are continually being updated based on experience. More

important, the quality of our clients is always changing, so their risk ratings must be re-evaluated and updated accordingly.




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CITIBANK’S RISK RATINGS

Citibank’sRisk

Rating

CorrespondingStandard &

Poor Rating Definition Characteristics1 AAA Largely risk free + Normally includes transactions with full cash

collateral; wholly owned subsidiaries or branches

with S&P AAA rating, or 100% guaranteed by

AAA-rated banks.

+ Superior credit risk, with unquestionable

repayment record.

2 AA Exceptional credit /

minimal risk

+ Excellent current and historical cash flows, very

strong balance sheet, dominant position in stable

industry.

+ Includes branches or wholly owned subsidiaries ofcompanies rated AA by S&P, or guaranteed by

AAA-1 rated bank.

+ May include facilities with excellent collateral

such as investment grade securities or rated bank

CDs.

3 A Good credit quality /

low risk

Excellent credit

quality / very low risk

+ Includes branches or wholly owned subsidiaries of

companies with A rating by S&P, or guaranteed

by AAA-2 rated banks.

+ Company well positioned in industry, probably

dominant.

+ Very healthy debt capacity and coverage ratios;

demonstrated ability to weather a downturn.

+ Citibank is confident in management in all key

positions.

+ Quality and timeliness of financial disclosure

above average.




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Citibank’sRisk

Rating


Poor Rating Definition Characteristics

4 BBB Satisfactory credit

quality; increasing

risk factors

Good credit

quality / low risk

+ Company well positioned in an industry that may

be moderately cyclical.

+ Good debt capacity, coverage, and other financial

ratios. Debt service coverage is better than

average for the industry.

+ Sound management at all key positions.

+ Banks are not primary source of funding.

5 * BB Acceptable (average)

credit quality, but

less stable

+ Company well regarded in industry, but not

necessarily a market leader.

+

Average debt service coverage, leverage levels,other financial ratios.

+ Able to weather a downturn, but with some

difficulty.

+ Sound management in most key positions.

6 * B Higher than average

risk; evidence of

quality risks; risk

rating may change

+ Company is not a market leader.

+ Industry may be cyclical.

+ Debt capacity, coverage, and other financial ratios

are acceptable, but not necessarily consistent

over several years.

+ Could weather a downturn for a short time.

+ Citibank is comfortable with management, but

would like more depth at key positions.

7 * CCC Substantial credit risk

and variability

potential; risk rating

likely to change

+ Company has weakened competitive position.

+ Industry may be heavily regulated, or new,

unfavorable regulations are forthcoming.

+ Company is close to full leverage, earnings are

under pressure. There is a willingness to pay

higher spreads. Some suppliers may require

Letters of Credit.

+ Citibank may lack confidence in management’s

ability to deal effectively with problems.+ There may be present or expected material

change, such as changes in the industry, in

company management, in economic or political

trends, etc. The implications of these changes are

not clear.




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Citibank’sRisk

Rating


Poor Rating Definition Characteristics8 * CC Special mention The borrower has credits which:

+ show evidence of weakness in its financial

condition; or

+ are subject to an unrealistic repayment program;

or

+ lack adequate collateral, credit information, or

documentation.

9 * C Substandard

credit quality

+ The borrower has credits for which the normal

repayment of principal and interest are in

jeopardy.

+ While no loss may be foreseen, a protracted

work-out period is possible.

10 * D Doubtful

Loss

+ The borrower has credits for which full payment

appears questionable.

+ A degree of eventual loss is anticipated, and

vigorous action is required to avert or minimize the

loss.

* Credits rated below investment grade (i.e. 5 or higher) may be more subject to adverseclassifications.




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Customer (Obligor) Risk Ratings

Debt rating

models

Customer risk ratings are assigned by using a debt rating model (DRM),if one is available, that has been approved for use by a member of the

Credit Policy Committee. A debt rating model is a statistical model thatmatches the profile of an individual customer against establishedstandard profiles for each risk rating to determine the appropriate risk rating for the customer. DRMs analyze both the quantitative financialdata of the customer and, for non-investment grade debt, qualitativefactors, including:

n Reliability of financial information

n Industry and competitive conditions

n Quality of management

n Environment in which the customer operates

Where an approved debt rating model is not available, risk ratings mustbe assigned on a judgmental basis according to guidelines that havebeen established to control this process. The customer risk rating isdetermined by the loss norm applicable to unsecured seniorobligations of the customer.

Facility Risk Ratings

Adjust customer

risk rating

To assign the final risk rating, which determines the loss normassociated with a facility, it may be necessary to adjust the customerrisk rating up or down to reflect specific considerations that willimpact the loss in the event of default. These factors include:

n Collateral type and value

n Documentation, which includes protective covenants and escapeclauses in the agreement

n Quality of the guarantees, and the strength of the guarantor




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n Product type, e.g. loan, forward contracts, securities, etc.

n Tenor, relative to market trends and prices

n Country issues, including the local legal system, politicaland economic conditions, and any cross-border issueswhich might affect the transaction

The quality of a customer is heavily weighted in establishing a facilityrisk rating and, therefore, most facilities of the same customer willhave the same risk rating. Cash-collateralized facilities areexceptions.

Risk-Adjusted Earnings

Premium

shareholder

income (PSI)

The expected return on the relationship is an important component of the account planning process and the development of risk acceptancecriteria. As we have seen, booked assets are assigned risk ratings basedon the customer's and/or the facility's risk profile. The same risk ratingused in the portfolio management system is applied to Citibank'scustomer-focused management process (CFMP). In this process, theconcept of premium shareholder income (PSI) is used to targetcustomers and to make transaction decisions based on actual andpotential risk-adjusted earnings.

PSI is derived by looking at a combination of the following: revenues,expenses, taxes, and calculations of expected loss and capital charges."Expected loss" represents the reasonably expected rate of loss on agiven portfolio of a specific risk rating. "Capital charges" is an attemptto capture the volatility surrounding thelosses we anticipate.

Revenue

– Expenses

Margin – Expected Loss

– Capital Charge

– Taxes

PSI




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Summary

A portfolio management system provides analytical tools for portfoliodecisions based on an established portfolio strategy. Portfolio

management should include:

n A target profile or concentration limits to achieve diversificationin terms of industries, geography, and risk ratings

n A target market that is expected to generate an acceptable levelof return on risk

n Pricing, origination, and distribution programs to meet theseobjectives

Risk rating is a key element of a portfolio management system. Therisk rating scale at Citibank rates each customer and each facility from1 to 10, with 1 being the highest quality rating and 10 the lowestquality. Customer risk ratings are assigned using debt rating modelswhere available or by judgmental criteria. They reflect the loss normthat has been calculated or estimated for unsecured obligations of theborrower; these ratings may be adjusted up or down for particularfacilities. The loss norm represents the probability of default in thenext 12 months multiplied by the

present value of expected credit costs in the event of default.

Earnings must be risk-adjusted to reflect revenues, expenses, taxes,and calculations of expected loss and capital charge. The result of thisadjustment is the premium shareholder income (PSI).

You have completed Unit Three: Managing Credit Risk in Citibank . Please proceed toProgress Check 3.2 to check your understanding. Then continue with the final unit in thiscourse: Managing Market Risk in Citibank.




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þ PROGRESS CHECK 3.2

Directions: Select the correct answer for the following questions. There is only one correctanswer unless otherwise stated in the question. Check your answers with theAnswer Key on the next page. If you answer any of the questions incorrectly,return to the appropriate section of the text and review the material.

Question 12: Check four objectives of a portfolio management system.

____ a) Identify a customer's position within the industry.

____ b) Communicate the risk profile of the portfolio.

____ c) Achieve risk-adjusted earnings that conform to corporate objectives.

____ d) Develop a credit policy manual.

____ e) Structure origination activities within parameters of concentration limits.

____ f) Obtain financial information for each customer.

____ g) Evaluate the acceptability of potential losses.

Question 13: The loss norm associated with a risk rating assigned to a customer or facilityrepresents:

____ a) a comparison, on average, of the amount of loss that resulted from thedefault of other customers and facilities.

____ b) the probability of default within twelve months multiplied by theeconomic loss in the event of default.

____ c) the reliability and validity of the average loss resulting from transactionsin a specific industry.

____ d) the average present value of a transaction over a twelve month periodmultiplied by the average loss resulting from market rate fluctuations.




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ANSWER KEY

Question 12: Check four objectives of a portfolio management system

b) Communicate the risk profile of the portfolio.

c) Achieve risk-adjusted earnings that conform to corporate objectives.

e) Structure origination activities within parameters of concentration

limits.

g) Evaluate the acceptability of potential losses.

Question 13: The loss norm associated with a risk rating assigned to a customer or facilityrepresents:

b) the probability of default within twelve months multiplied by the

economic loss in the event of default.




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Question 14: A debt rating model:

____ a) matches the individual profiles of customers against each other.

____ b) analyzes only the quantitative financial data of a customer.

____ c) must be used for assigning risk ratings.

____ d) must be approved by a member of the Credit Policy Committee.

Question 15: Premium shareholder income is the result of:

____ a) adjusting annual earnings to reflect expected loss and capital charges.

____ b) subtracting the loss norm from annual earnings.

____ c) estimating the cost of credit and capital over a twelve month period.

____ d) adjusting after tax income to reflect earnings and the loss norm.




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ANSWER KEY

Question 14: A debt rating model:

d) must be approved by a member of the Credit Policy Committee.

Question 15: Premium shareholder income is the result of:

a) adjusting annual earnings to reflect expected loss and capital

charges.



Unit 4





Unit 4





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UNIT 4: MANAGING MARKET RISK IN CITIBANK

INTRODUCTION

In Unit Three, we focused on the process of planning, originating, and managing creditexposures. In this unit, we will present an overview of Citibank's market risk managementphilosophy and the centrally established policies and procedures that serve as guidelines fora decentralized market risk management process.

UNIT OBJECTIVES


n Recognize some characteristics of price risk and liquidity risk management

n Identify segments of the market risk management organization

n Recognize the five steps of the Market Risk Policy Committee risk management process

n Understand the liquidity and price risk limit approval process in Citibank



4-2 MANAGING MARKET RISK IN CITIBANK

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OVERVIEW OF THE MARKET RISK PROCESS

Market risk is a generic term for price risk and liquidity risk. It isfundamental to our business of providing financial services tocustomers and intermediating markets. Market risk is most effectivelymanaged by professionals who have close, ongoing relationships withcustomers, products, and markets.

Market risk management, like credit risk management, is a dynamicprocess that combines corporate parameters with Line Managementresponsibilities for identifying, analyzing, and controlling risk.

Essential elements of the market risk process include limits, regularreporting, and continuous validation of the adequacy and integrity of policies, assumptions, practices, and procedures at both the policy andline level.

Managing Price Risk

Sensitivity of

earnings to

market factors

changes

Price risk exposure is the sensitivity of earnings to changes in threetypes of market factors: interest rates, commodity prices (includingforeign exchange rates), and volatilities in options. A business will

assume price risk commensurate with its objectives and earnings, itscapacity to manage risk, and the sophistication of the local markets.

Price risk management is a decentralized process balanced by strongcentralized controls. An effective price risk management systemprovides techniques for:

n Assessing profit and loss to date at any point in time

n Analyzing profit and loss sensitivity to changes in market factors

n Monitoring and controlling the risk



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The bank's market risk management system accommodates thediverse price risks and risk management systems of the variousbusinesses. It provides a meaningful measure and control of pricerisk through:

n Potential loss amount (PLA) limits, which limit the potential

P&L (profits and losses account) impact derived from tradingportfolios

n Earnings at risk (EAR) limits, which limit the potential decreasein future earnings derived from accrual portfolios

This amount of earnings that may be placed at risk is limited to apercentage of forecasted annual earnings. To observe a price risk

limit, we must:

n Know our current profit and loss to date

n Calculate the sensitivity to changes in market prices

n Estimate the amount that potentially could be at risk on existingpositions due to standard changes in market prices

The standard change in a market price is usually based on its historicvolatility or in the volatility implied in options, although it is

sometimes necessary to base it on management judgment.

Trading portfolio

marked-to-

market daily

Citibank's trading portfolios are managed to support customer needsand to take advantage of short-term market opportunities. Tradingportfolio price risks are marked-to-market daily, with gains andlosses reflected in current earnings. Marking-to-market isaccomplished by simulating the orderly liquidation of a position,which means determining the price at which each position may beliquidated if it becomes necessary to do so. To ensure that thepotential impact of changes in market prices on earnings is

controlled within acceptable limits, trading portfolios are subject towell-defined price risk limits which, when exceeded, trigger specificmanagement actions.




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Accrual portfolio Citibank’s accrual portfolios consist of all assets and liabilities(including some derivative contracts) that are not intended to be soldprior to maturity. Transactions in an accrual portfolio are representedeither by non-negotiable instruments or negotiable instruments used

to hedge exposures of accounts that are intended to be held untilmaturity.

Profits and losses in these portfolios are “accrued” during the life of the contracts. This means that the mark-to-market value doesnot affect the profit and loss (P&L) account — it is only used formanagement decision purposes. Therefore, price risk associatedwith an accrual portfolio should be differentiated from price risk generated in a trading portfolio.

Managing Liquidity Risk

Essential for

maintaining

reputation in

the market

Citibank defines liquidity as having funds available at all times tomeet fully and promptly all contractual obligations. Effectiveliquidity management is also essential to maintaining marketconfidence, attaining the flexibility necessary to capitalize onbusiness expansion opportunities, and protecting the corporation'scapital base.

Liquidity risk affects the life of the corporation, because withoutliquidity a business may be forced to shut down. The liquidity of eachCitibank business and legal entity is managed through a well-definedprocess that includes liquidity risk limits and global and localcontingency funding plans.

There are two types of risk in liquidity management: funding liquidityrisk and trading liquidity risk.




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F u n d i n g L i q u i d i t y R i sk

Funds not

available

when needed

Funding liquidity risk is the risk that funds will not be available to meetfinancial commitments when they are contractually due or that funds

will not be available to take advantage of attractive businessopportunities. The process for achieving funding liquidity consists of:

n Liability management, which focuses on diversification of sources and instruments, market share, and maturities

n Asset sales (where we sell off individual assets) and assetsecuritization (where we create and sell a new instrument thatrepresents many individual loans)

n A contingency funding plan, which is a formal plan for

maintaining liquidity under adverse conditions

Liquidity limits Managing funding liquidity risk is accomplished by setting limits on theamount of cummulative negative cash flows for a given period. Theselimits are monitored daily and enforced through information gathered inthe Maximum Cumulative Outflow Report (MCO) — a cash flowforecast based on “business-as-usual” assumptions.

Limits are also set on cross currency funding activity, where assets in

one currency are funded with liabilities in another currency.

Contingency

funding plan

Additionally, management is required to prepare a Contingency FundingPlan (CFP), which is an analysis of liquidity assuming potential adversescenarios. The results of this analysis show the appropriateness of current or requested MCO limits.

Liquidity triggers To cover specific market structures and practices, management is alsorequired to set some triggers on balance sheet ratios and/or marketshare per product. These ratios are intended to alert management against

a possible adverse balance sheet structure or potential liquidityproblems.




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T r a d i n g L i q u i d i t y R i s k

Inability to

liquidate price

risk positions

Trading liquidity risk is the risk that the bank will not be able to instantlyliquidate price risk positions without changing market prices, attracting

the attention of other market participants, or compromising oncounterparty quality.

Trading liquidity is achieved by taking risk positions with specificcharacteristics that relate position size to a marketable amount.Characteristics to avoid include:

n A large percentage of market share

n Infrequently traded currencies and instruments

n Tenors of unusual length

n Excessive concentration of maturities

n Maturities that fall on a week-end or holiday

Trading liquidity is also the result of good credit standing. Not havingtrading liquidity may affect our ability to do business. Itis important to be perceived as a good counterparty so that othermarket participants will want to provide lines for trading activities.

MARKET RISK MANAGEMENT ORGANIZATION

The market risk management organization at Citibank consists of theMarket Risk Policy Committee (MRPC), the Regional Treasurer, theCountry Treasurer, and the Country Asset and Liability Committee

(ALCO). Let's look at the responsibilities of each of theseorganizational elements.




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MRPC

Oversees

market risk

management process

The Market Risk Policy Committee (MRPC) establishes corporatepolicy and standards, and oversees the market risk management

process. It acts as a check and balance for the risk managementprocess in each business to ensure that market risks are properlyrecognized and appropriately managed, that excessiveconcentrations are avoided, and that the return on the assumed risk is satisfactory. This process fits Citibank's policy of decentralizedLine Management with strong centralized reporting and controls andthe bank's need to adapt to the volatile nature of market risks in anefficient and timely manner.

Regional Treasurer

Balance sheet

and liquidity

management

Regional Treasurers are responsible for geographic regions orcountries. The role of the Regional Treasurer is to act as liaisonbetween the MRPC and the countries / ALCOs for balance sheet andliquidity management issues.

Principal liquidity risk responsibilities include managing:

n Regulatory capital and balance sheet liquidity gap risks

n Liquidity relating to specific geographic markets and currencies

n Exchanges and clearing houses

n Availability of counterparties




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Country Treasurer

Funding strategy

and process

The Country Treasurer is responsible for ensuring that the country'sliquidity risk management process complies with MRPC policy and

procedures. S/he is responsible for developing a funding approachand funding process that is flexible enough to encourage transactions,yet rigorous enough to protect country liquidity. Success dependson:

n An understanding of the price risk characteristics and impact onliquidity of products offered by the country's businesses

n Knowledge of factors that influence market demand for thecountry's business

n Skills in building consensus on funding objectives and strategiesamong representatives to the Country ALCO

ALCO

Liquidity,

sufficient capital

and appropriate

funding

The Country Asset and Liability Committee (ALCO) ensures that thecountry maintains adequate liquidity, has sufficient capital to meetregulatory and business needs, and has appropriate funding for

business growth. ALCO must make sure that individual businessstrategies are consistent with these objectives and that the resultingtotal country balance sheets, based on Risk-adjusted Asset Principles(RAAP) and Generally Accepted Accounting Principles (GAAP), don'tdiffer materially from forecast.

The Country ALCO, including the CCO (chairman), and CountryTreasurer are jointly responsible for the following issues affecting theliquidity of each of the country's legal vehicles:

n Diversification of funding sources, maturities, and instruments

n Contingency plans for each vehicle that are consistent with the

business operations and market capacity




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n Compliance with local and US regulations on the flow of funds

between legal vehicles, which affect contingency funding plansand allocation of country liquidity limits

In this context, the corporate role of the CCO (in addition to thisindividual's role as manager of a business) is extremely important.

Strategies for

funding in normal

and contingency

environments

A Country Funding and Liquidity Plan and a Contingency FundingPlan are prepared jointly by the Country Treasurer and the Country

ALCO at least annually. They include an overview of the fundingsituation and strategies for funding in normal and contingencyenvironments for each vehicle in a country. On the basis of theirreview of each vehicle's funding position and requirements, theCountry Treasurer, the Country Corporate Officer, the Country

ALCO, and the Regional Treasurer determine the appropriateliquidity limits for each vehicle and recommend to the MRPC theconsolidated country liquidity limits.

RISK MANAGEMENT PROCESS

The MRPC incorporates five major steps in the risk managementprocess:

1) Risk identification

2) Risk measurement and risk/return evaluation

3) Evaluation of risk management capacity

4) Limit setting

5) Ongoing validation

Let's define each step of the process.




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Risk Identification

Businesses identify the risks associated with their activities andestablish plans for measuring and managing those risks in formal

product programs. Product programs identify and quantify priceand liquidity risks and describe the procedures and operating systemsfor controlling these risks. The MRPC approves product programsaccording to corporate standards and may compare products acrossbusinesses to identify excessive risk concentrations.

Risk Measurement

Market exposures vary by business. The risk measurement andmanagement processes developed by each business mustaccommodate individual needs within the overall framework of asensitivity approach. MRPC requires all risk management systemsto meet the following standards:

n Accurate measurement of price and liquidity risks that facilitatesthe on-line management of those risks

n Capacity to translate price risk sensitivities into potential lossamounts or earnings at risk

n Methodology for avoiding excesses in a country's price risk limits

n Means for assuring satisfactory returns on both price risk andliquidity risk




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Evaluation of Risk Management Capacity

The capacity of a business to manage price and liquidity risk is theresult of:

n Staff experience

n Systems efficiency and reliability

n Market depth

Processing systems are verified on a regular basis to ensure that theyadhere to corporate standards and are evaluated for their capacity toaccommodate increased volume and additional products.

Limit Setting

Requested at

business level;

approved by

MRPC

Market risk positions are controlled by price risk limits based onthe size and nature of a business. Most important, however, the sizeof price risk limits is based on the relationship of the limits toexpected associated profits. Price risk limits are requested at thebusiness level and reviewed at higher levels of the businessorganization. Final approval is granted by MRPC.

Requests for liquidity risk limits from different businesses within acountry are aggregated by the Country Treasurer and approved by

ALCO at the country level. Thereafter, approval for one singleliquidity risk limit for the country as a whole is requested throughthe Regional Treasurer from MRPC, which establishes corporateliquidity policy and finally approves liquidity risk limits.




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Ongoing Validation

Identify and

manage evolving

risk elements

Market risk management is an evolving process. Various factorssuch as market changes, product developments, and technological

advances affect market risk management policies and procedures.MRPC ensures that current policies and practices effectively identifyand manage these evolving risk elements.

LIMIT APPROVAL PROCESS

Three signatures

plus approval by

MRPC member

Many individuals participate in the approval process and indicate

by signing off. However, the approval authority and accountability mustbe clearly identified and consist of three signatures plus final approvalby an MRPC member. In addition to the business manager, CountryTreasurers and Country Corporate Officers are required to sign allprice risk limits to indicate concurrence on liquidity and regulatoryissues. The approving parties may require an additional sign-off by abusiness or product specialist.

The limit-setting processes for price and liquidity exposures areclosely linked. However, there are differences in the review and

approval processes, especially in countries where markets are not welldeveloped.

Price Risk Limits

Business level managers request price risk limits and submit themto higher levels of the business organization for review. The threesignatures include two from the business organization and one fromrisk management (Country Risk Manager, Regional / Division Risk

Manager). The MRPC reviews and approves price risk limits that havebeen recommended by senior line management.




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MRPC approval of limits depends on the committee's evaluation of:

n The risk / return trade-offs that result from market risks

n

The size and distribution of aggregate price risks

n A capacity of a business to manage the price risk implied by therecommendation

Liquidity Risk Limits

Liquidity management is a business and corporate responsibility. The

MRPC develops a process to protect liquidity across businesses,vehicles, currencies, and countries with enough flexibility toencourage transaction efficiency. It establishes corporate liquiditypolicy and approves liquidity limits requested by vehicles andcountries through Country Treasurers, Regional Treasurers, andCountry ALCO.

The Country Treasurer (through ALCO and its chairman, the CCO)is responsible for managing liquidity in the country. After discussionwith each of the local businesses, s/he prepares a Funding andLiquidity Plan for the country that complies with local and USregulations governing the flow of funds between vehicles andbusinesses.

SUMMARY

Market risk management is a dynamic process combining line marketmanagement with effective corporate supervision. Increasingly-complex financial products and instruments and closer relationshipsbetween markets create an environment of continuously evolving

exposures. Limits and regular reporting are essential elements of themarket risk management process, along with ongoing validation of theadequacy of policies and procedures.




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Price risk exposure is the sensitivity of earnings to changes in interestrates, commodity prices (including foreign exchange rates), andvolatilities in options. "Potential Loss Amount (PLA) and “Earnings-

at-risk (EAR) limits" are the measures of price risks and limit the

earnings impact of standard changes in market prices. The size of these limits relates directly to budgeted associated trading profits.

Price risks in trading portfolios are marked-to-market daily to reflectgains and losses in earnings and to ensure that these risks remainwithin clearly defined limits.

Accrual portfolios are represented by all assets and liabilities that arenot intended to be sold prior to maturity. Profits and losses are notmarked to market, but are “accrued” during the life of the contracts.

Funding liquidity risk is managed by putting limits on the amountof the cummulative negative cash flows for a given period and byanalyzing liquidity under stress conditions. There are also triggers formarket shares and balance sheet ratios. Trading liquidity risk iscontrolled by avoiding concentrations as well as maintaining the bank'scredit standing and its image as a good trading partner.

The market risk management organization is headed by the MarketRisk Policy Committee (MRPC), which ensures that market risks arerecognized and managed and that excessive concentrations acrossbusinesses are avoided. Regional Treasurers act as a liaison betweenthe MRPC and the country ALCO for balance sheet and liquiditymanagement issues. The Treasurer in each country is responsible fordeveloping a funding strategy and funding plans assuming differentcontingencies that protect the country's liquidity. The Country Assetand Liability Committee, chaired by the CCO, ensures liquidity,sufficient capital, appropriate funding, and a country balance sheetconsistent with the budget / forecast.

The MRPC risk management process includes risk identification,risk measurement and risk / return analysis, evaluation of risk management capacity, limit setting, and ongoing validation.




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The limit approval process for both price risk and liquidity risk requires three signatures in addition to final approval by a memberof the MRPC. Business level managers request price risk limits andsubmit them to higher levels of the business organization for review. A

single liquidity limit is requested for the country as a whole throughCountry Treasurers, Country ALCO, and Regional Treasurers.

Congratulations! You have completed the final unit of the Introduction to Risk Managementcourse. Please answer the questions in Progress Check 4 to check your understanding of the introductory material on how we manage market risk in Citibank .




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þ PROGRESS CHECK 4

Directions: Select the correct answers for the following questions. There is only onecorrect answer unless otherwise stated in the question. Check your answerswith the Answer Key on the next page. you answer any of the questionsincorrectly, return to the appropriate section of the text and review thematerial.

Question 1: Price risk exposure is:

____ a) the volume of business that is exposed to changes in market prices.

____ b) a situation in which we hold positions that are sensitive to market changesin their prices.

____ c) a position that should be avoided because it will decrease profits.

____ d) a type of credit risk in which earnings are exposed to improper pricingpractices.

Question 2: To observe a potential loss amount limit, we must: (Select two)

____ a) trigger the mark-to-market process when a loss on existing positionsoccurs.

____ b) understand the amount that potentially can be lost on existing positions.

____ c) determine the price at which each position will be liquidated if marking-to-market indicates a profit.

____ d) calculate current profits and losses each day by simulating the liquidationof positions.




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ANSWER KEY

Question 1: Price risk exposure is:

b) a situation in which we hold positions that are sensitive to market

changes in their prices.

Question 2: To observe a potential loss amount limit, we must: (Select two)

b) understand the amount that potentially can be lost on existing

positions.

d) calculate current profits and losses each day by simulating the

liquidation of positions.




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Question 3: Select three elements of the funding management process.

____ a) Diversification of liability sources and instruments

____ b) Creation and sale of new instruments that represent many smallertransactions

____ c) A formal plan for maintaining liquidity under different adverse conditions

____ d) Limits on the amount of positive and negative cash flows for a givenperiod

____ e) A liquidity maintenance fund for use in contingent business environments.

Question 4: Select three types of positions to avoid in order to achieve trading liquidity.

____ a) Tenors of unusual length

____ b) Instruments that represent other instruments

____ c) Tenors of less than one year

____ d) A large percentage of market share

____ e) Infrequently traded currencies and instruments




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ANSWER KEY

Question 3: Select three elements of the funding liquidity management process.

a) Diversification of liability sources and instruments

b) Creation and sale of new instruments that represent many smaller

transactions

c) A formal plan for maintaining liquidity under different adverse

conditions

Question 4: Select three types of positions to avoid in order to achieve trading liquidity.

a) Tenors of unusual length

d) A large percentage of market share

e) Infrequently traded currencies and instruments




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Question 5: Match the segment of the Market Risk Management Organization with itsrole / responsibility.

_____ MRPC

_____ Regional Treasurer

_____ Country Treasurer

_____ ALCO

a) Acts as liaison.

b) Ensures that the country maintains liquidity, hassufficient capital, and has appropriate funding forgrowth.

c) Ensures that the country's liquidity risk management process complies with corporate

policy and procedures.

d) Establishes corporate policy and standards andoversees the market risk management process.

Question 6: Risk measurement and management processes developed by each businessmust:

____ a) provide a system for preventing the business from assuming price risk

positions.

____ b) be approved by the country's ALCO.

____ c) allow for the individual needs of a business while adhering to MRPC

standards.

____ d) provide a formula for calculating a satisfactory risk/return ratio.




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ANSWER KEY

Question 5: Match the segment of the Market Risk Management Organization with itsrole / responsibility.

d MRPC

a Regional Treasurer

b Country Treasurer

c ALCO

a) Acts as liaison.

b) Ensures that the country maintains liquidity, hassufficient capital, and has appropriate funding forgrowth.

c) Ensures that the country's liquidity risk management process complies with corporate

policy and procedures.

d) Establishes corporate policy and standards andoversees the market risk management process.

Question 6: Risk measurement and management processes developed by each businessmust:

c) allow for the individual needs of a business while adhering toMRPC standards.




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Question 7: Identify the five major steps that MRPC incorporates in the risk managementprocess:

____ a) Setting price and liquidity risk limits

____ b) Evaluating and updating policies and procedures to accommodate evolvingfactors that affect market risk

____ c) Identifying target markets for risk-taking activities

____ d) Rating customers to establish their "riskiness" for the bank

____ e) Assessing a business for its capacity to manage price and liquidity risk

____ f) Appointing the risk management team for each country

____ g) Assuring that each business meets MRPC standards for measuring risk

____ h) Assuring that each business establishes business plans that identify andquantify price risks and liquidity risks and describe the risk managementprocess for controlling risks

Question 8: Select three characteristics that MRPC evaluates before approving abusiness's price risk limit request.

____ a) Size and distribution of aggregate price risks

____ b) Two approving signatures from the business organization

____ c) Capacity of a business to manage the recommended price risk limit

____ d) Ability to generate enough business to satisfy customer needs

____ e) Risk / return trade-offs that result from market risks




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ANSWER KEY

Question 7: Identify the five major steps that MRPC incorporates in the risk managementprocess:

a) Setting price and liquidity risk limits

b) Evaluating and updating policies and procedures to accommodate

evolving factors that affect market risk

e) Assessing a business for its capacity to manage price and liquidity

risk

g) Assuring that each business meets MRPC standards for measuring

and managing risk

h) Assuring that each business establishes business plans that identify

and quantify price risks and liquidity risks and describe the risk

management process for controlling risks

Question 8: Select three characteristics that MRPC evaluates before approving a

business's price risk limit request.

a) Size and distribution of aggregate price risks

c) Capacity of a business to manage the recommended price risk limit

e) Risk / return trade-offs that result from market risks




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Question 9: The limit approval process for price risk and liquidity risk requires:

____ a) sign-off by a business or product specialist.

____ b) concurrence from regulatory agencies that limits do not violate anyrules and regulations.

____ c) that approval authority and accountability be assigned to businesslevel managers for final review and approval of limit requests.

____ d) that approval authority and accountability be clearly identified and consistof three signatures plus final approval by MRPC.




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ANSWER KEY

Question 9: The limit approval process for price risk and liquidity risk requires:

d) that approval authority and accountability be clearly identified

and consist of three signatures plus final approval by MRPC.



A endices





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APPENDIX

GLOSSARY

Assets andLiability

Committee(ALCO)

Committee in each country that makes sure the country maintainsadequate liquidity, has sufficient capital to meet regulatory andbusiness needs, and has appropriate funding for business growth

Business Risk

ReviewGroup that reviews the policies and rules set by the CPC and MRPC

and the practices of Line Management to ensure that portfolios arestructured to achieve Management Committee's goals

Clearing Risk Risk that the bank may not be reimbursed on the same value date forpayments that are made on behalf of customers

Concentration

LimitsLimits set by Group Executive Vice-presidents, with approval of theCredit Policy Committee to control Citibank's exposure to variousportfolio risk dimensions

Contingent

Lending RiskRisk that potential customer obligations will become actualobligations and will not be settled on time

Country Risk Risk that economic problems, political disturbances, or sovereignactions within a country may make it impossible to get money out of a country or to convert local currency into a foreign currency

Country

TreasurerIndividual who ensures that the country's liquidity risk managementprocess complies with MRPC policy and is flexible enough toencourage transactions while protecting country liquidity

Credit PolicyCommittee

Senior-level staff group that establishes policies for credit risk and

equity risk, including approval hierarchies, rules and standardscovering credit products, and limits for portfolio concentrations



G-2 GLOSSARY

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Credit Risk Risk that financial obligations to Citibank will not be paid on timeand in full as expected or contracted, resulting in a financial lossfor the bank

Debt-rating

Model

Model that matches the profile of an individual customer against

established standard profiles for each risk rating to determine theappropriate risk rating for the customer

Direct Lending

RiskRisk that actual customer obligations will not be settled on time

Disclosure Risk Risk that as an agent for other investors, either as an underwriteror as an advisor on a transaction, the bank fails to disclose certaininformation or discloses incorrect information

DocumentationRisk

Risk that the documentary evidence on which we depend to enforceour rights under contracts or transactions may not be complete,correct, or enforceable

Earnings-at-risk

LimitMeasure of aggregate price risk which is intended to limit thenegative variance from the monthly budget for trading revenues

Equity Risk Risk of fluctuation in the value of equities when the bank investsin, holds, or receives equity, equity-like securities, or other juniorsecurities in non-affiliated entities

Fiduciary Risk Risk associated with the responsibility of acting as a trustee for thirdparties

FundingLiquidity Risk

Risk that funds will not be available to meet financial commitmentswhen they are contractually due or that funds will not be available totake advantage of attractive business opportunities

Issuer Risk Risk that the market value of a security or other debt instrument

that the bank intends to hold for a short period of time may changewhen the perceived or actual credit standing of the issuer changes,thereby exposing the bank to a financial loss



GLOSSARY G-3

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Legal /Regulatory

Risk

Risk that occurs whenever the bank, a related corporate entity(such as a non-bank subsidiary or affiliate), a transaction, or acustomer is subject to a change in exposure resulting fromregulatory, civil or criminal sanctions, or litigation

Lending Risk Risk associated with extensions of credit and/or credit-sensitiveproducts, such as loans, overdrafts, placements, letters of credit,and guarantees, where the bank bears the full risk for the entirelife of the transaction

Line

ManagementIndividuals who are responsible for developing procedures toimplement the policies and rules established by the CPC and MRPC

Liquidity Continuous availability of funds to meet fully and promptly all

contractual obligations

Liquidity Risk Risk that Citibank will be unable to fulfill its contractual obligationswhen they are due

Loss Norm Probability of default within the next 12 months, expressed as apercentage, multiplied by the economic loss in the event of default(LIED), also expressed as a percentage; the resulting loss norm isexpressed in basis points

ManagementCommittee

Committee that establishes the risk tolerance level for the bank and sets the goals and objectives for risk management activities

Market Risk Generic term for price risk and liquidity risk

Market Risk

Policy Committee(MRPC)

Committee that establishes corporate policy and standards, andoversees the market risk management process

Marking-to-

MarketProcess of determining the current market value of a position;

simulating the liquidation of a position

MaximumCumulative

Outflow Report(MCO)

Report used to monitor and manage limits on the amount of negativecash flows for a given period



G-4 GLOSSARY

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Net Position Difference between assets plus any unliquidated purchases on oneside and liabilities plus any unliquidated sales on the other side ina commodity such as foreign exchange

Origination Process of soliciting a customer, responding to customer requests,

evaluating risk, and setting up a transaction within the guidelinesof well-defined target market criteria, product configurations, andrisk acceptance criteria

Political(Sovereign)

Risk

Risk that the actions of a sovereign government (such asnationalization or expropriation) or independent events (such as war,riots, or civil commotion) may affect the ability of customers in thatcountry to meet their obligations to Citibank

PremiumShareholder

Income (PSI)

Risk-adjusted earnings that reflect both the expected cost of creditand the cost of capital necessary to fund an asset

Pre-settlementRisk

Risk that the trading partner fails before maturity date and the marketrate changes, resulting in a contract rate that is more attractive thanthe prevailing market rate

Price Risk Risk resulting from one or several financial contracts of such anature that a change in financial market prices would impact ourprofit and loss statement

Problem

ClassificationSystem

Classification system that categorizes exposures by severity of actualand potential risk of loss

RegionalTreasurer

Individual who acts as liaison between the MRPC and the countries /

ALCOs for balance sheet and liquidity management issues

Risk AcceptanceCriteria (RAC)

Standards for extending credit to ensure that individual exposures andthe overall portfolio are consistent with business objectives

Risk Ratings Ratings assigned to customers and facilities on a scale of one toten, with one being the best rating



GLOSSARY G-5

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Senior CreditOfficers

Customer experts who are responsible for preserving the integrity of credit policies and exercising balanced, independent credit judgment

Senior SecuritiesOfficers

Specialists who apply their experience and expertise to risk andprocess decisions for underwriting and distribution activities

Settlement

RiskRisk that the counterparty will fail on the maturity date of a contractinvolving an exchange of assets. The risk is that we deliver our sideof the transaction but do not receive deliveryfrom the counterparty.

Systems Risk Risk arising from the operational aspects of the product, includingsystems which can be both external and internal to the bank

TargetMarket Segment of the market that is of interest to a business unit basedon the risk profile and perceived potential return

Trading LiquidityRisk

Risk that the bank will not be able to liquidate assets quickly enoughwhen cash is needed, or liquidate price risk positionswhen an adverse price change is expected

Transfer(Cross-border)

Risk

Risk that funds either cannot be converted into foreign currencyfunds or that converted funds cannot be moved past an exchangecontrol border

Yield Curve Interest rates for different maturity dates based on the expectationsof market participants for the trend of future interest rates



G-6 GLOSSARY

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Index





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INDEX

A

Asset and Liability Committee (ALCO) 4-6, 4-8, 4-14

B

Business Risk Review 2-2, 2-5, 2-9, 2-13, 2-15, 3-1, 3-20, 3-21,3-23, 3-24, 3-26

C

Clearing Risk 1-4, 1-8

Concentration Limits 3-3—3-5, 3-8, 3-18, 3-20, 3-39, 3-40, 3-

47Contingent Lending Risk 1-3—1-5

Country Risk 1-14, 1-15, 1-24, 4-12

Country Treasurer 2-7, 4-6, 4-8, 4-9, 4-11—4-13, 4-15

Credit Policy Committee 2-2, 2-4—2-6, 2-8—2-10, 2-12, 2-13, 2-15,3-3—3-5, 3-18, 3-26, 3-39, 3-45

Credit Risk 1-2, 1-3, 1-6—1-8, 1-12—1-14, 1-16,1-22—1-24, 2-4, 2-8—2-10, 2-15,3-1, 3-19, 3-20, 3-22, 3-42, 3-43, 4-2

D

Debt-rating Model 3-39, 3-42—3-44

Direct Lending Risk 1-3—1-5, 1-7

Disclosure Risk 1-14, 1-18, 1-20, 1-24

Documentation Risk 1-14, 1-18, 1-20, 1-24

E

Earnings-at-risk Limit 4-3, 4-10, 4-14

Equity Risk 1-14, 1-15, 1-20, 1-24, 2-4

F

Fiduciary Risk 1-14, 1-17, 1-20, 1-24

Funding Liquidity Risk 1-12, 1-14, 4-4, 4-5, 4-14



1-2 INDEX

Version 2.0 v05/15/96

p01/10/00

I

Issuer Risk 1-3, 1-54, 1-8, 1-12—1-14

L

Legal / Regulatory Risk 1-14, 1-19, 1-21, 1-24

Lending Risk 1-4

Line Management 2-1, 2-2, 2-4, 2-5, 2-8—2-10, 2-12—2-15, 3-1,3-3, 3-4, 3-8, 3-9, 3-18, 3-20, 3-23, 3-39,4-2, 4-7, 4-10, 4-12

Liquidity 1-8, 1-11, 1-12, 4-1, 4-4—4-9, 4-11—4-15

Liquidity Risk 1-8, 1-9, 1-11—1-14, 4-1, 4-2, 4-4—4-8, 4-10,4-11, 4-13—4-15

Loss Norm 3-40, 3-41, 3-45, 3-47

M

Management Committee 2-2, 2-3, 2-5, 2-6, 2-8, 2-9, 2-12, 2-13, 2-15,3-3, 3-4, 3-5, 3-18, 3-39

Market Risk 1-2, 1-7—1-9, 1-12—1-14.1, 1-24, 2-1, 2-6,2-7, 2-12, 4-1—4-3, 4-6, 4-7, 4-11—4-15

Market Risk Policy Committee 2-2, 2-6—2-8, 2-15, 4-1, 4-6—4-15(MRPC)

Marking-to-Market 4-3

Maximum Cumulative Outflow 4-5Report (MCO)

N

Net Position 1-10

O

Origination 3-3, 3-9, 3-14, 3-17, 3-18, 3-20, 3-21, 3-26,3-39, 3-40, 3-47



INDEX I-3

P

Political (Sovereign) Risk 1-14—1-16, 1-20, 1-22

Premium Shareholder Income (PSI) 3-46, 3-47

Pre-settlement Risk 1-4, 1-6—1-8, 1-12—1-14, 3-19Price Risk 1-5, 1-6, 1-8, 1-9, 1-12, 1-13, 4-1—4-4, 4-6,4-8, 4-10—4-15

R

Regional Treasurer 2-7, 4-6, 4-7, 4-9, 4-11, 4-13—4-15

Risk Acceptance Criteria (RAC) 2-9, 3-3, 3-4, 3-7—3-9, 3-21, 3-25, 3-26, 3-46

Risk Ratings 3-1, 3-5, 3-9, 3-19, 3-20, 3-23, 3-24, 3-39—3-47

S

Senior Credit Officers 2-6, 2-10, 2-11, 2-13, 2-15

Senior Securities Officers 2-6, 2-10, 2-11, 2-15

Settlement Risk 1-4, 1-7, 1-12—1-14

Systems Risk 1-14, 1-19, 1-20, 1-24

Documents

Citibank Latin America Training and Development Center - Introduction to Risk Management