Citi CIB Advanced Risk Issues

1. Advanced Risk Issues“Seeing Around Corners”Summary and ConclusionsWhy were We Here?IstanbulMarch, 2007

2. Citi CIBAdvanced Risk Issues Revenue Growth and Risk Management in a Complex Global Bank

4. The Economist – Survey of International Banking – May, 2006 • Banks the world over are scrambling to become larger… • But at some point diseconomies of scale will also start creeping in, with management finding it harder to summarize everything that is going on in the bank • This includes the neglect of concealed risks and the failure of internal controls • This problem afflicted Citigroup in 2002 – 2005 when it was rocked by a string of compliance problems • Risk management, the rock on which any contemporary bank rests, scarcely existed as a profession outside the insurance industry until the 1970’s

5. Moody’s 2005 Securities Industry Outlook • “For all global trading and market-making firms, highly-skilled risk management - broadly defined - is an absolute necessity for the business model. • “A robust corporate culture remains critical for balancing short-term competitive pressures and the long-term interests of a franchise. • In a hotly competitive arena, fraught with litigation and regulatory risk, an investment bank needs a collective sense of right and wrong.

6. Advanced Risk Issues The Market’s View of Risk Management • “The financial innovations that have made risk transfer and hedging possible have increased the complexity of risk management, both financial and operational.” • “If a bank can establish risk management as a core competency, I think that’s something the market would value.” • “No model,, and no software package, no matter how sophisticated, can ever replace the skills of a trained, experienced and conscientious risk manager”

7. Advanced Risk IssuesThe Market’s View of Risk Management • “NAB’s internal control systems failed at every level to detect the irregular currency options trading. As long as the business unit turned a profit, other shortcomings could be overlooked.” • “Barings – There may be a temptation to view this debacle as being caused by just one individual – the “rogue trader” – but in reality the fiasco should be attributed to the underlying structure of the firm, and particularly to the lack of internal checks and balances.”

8. Private leveraged funds have become an important source of protection to regulated institutions by being large sellers of credit insurance in the rapidly growing market for credit default swaps • These changes in market participants have occurred in conjunction with a dramatic acceleration in number and type of derivative instruments. • These developments have likely had the important impact of allowing for a more efficient distribution and more effective management of risk. • All of these changes should move the market in the direction of fostering the efficient allocation of credit and capital formation, and thus enhancing the economy’s real growth potential. • Stress testing and scenario analysis have become central to the process of risk management

10. Federal Reserve Written AgreementJuly, 2003 • “NOW, THEREFORE, Citigroup and the Reserve Bank hereby agree as follows:…….within 60 days of this Agreement, Citigroup shall submit to the Reserve Bank an acceptable written legal and reputational risk management program applicable to Citigroup and its subsidiaries.

11. Fed Ties the Hands of CitigroupNo Major Acquisitions Allowed Until Its Problems Are FixedTHE WALL STREET JOURNALPage “C1”March 18, 2005 The Federal Reserve barred Citigroup Inc. from major acquisitions until the company fixes regulatory problems that have gotten the financial-services giant in trouble around the world, raising the stakes for Chief Executive Charles Prince in his drive to overhaul the bank's ethics.

12. "CLAWS AND FANGS"Business Week October 4, 2004 "The constraint on Citi's growth is not its market size, nor its capital," says Bernstein's Mason. "It may well be that Citi can't achieve its growth ambitions because it cannot safeguard itself properly from regulatory and reputation risk."

16. Moody's Investors Service upgrades the ratings of Citibank N.A. to Aaa for long-term deposits and to A for financial strength September 26, 2006 • The firm has made progress on strengthening culture and improving controls, and has not suffered a major control problem since having to close its Japanese private bank. • However , management must continue to solidify cultural change, notwithstanding shareholder pressure for earnings growth • Moody's assessed the effectiveness of risk controls, measurement and information infrastructure as well as the firm's risk governance and culture.

17. Strong earnings generation from an extraordinarily diverse set of businesses allows Citigroup Inc. (Citi; AA/Stable/A-1+) to cover some of the high risks that it incurs. Citi has also achieved a substantial change in its control environment in the aftermath of a wave of heavy litigation expenses and criticism of its business practices from regulators around the world. “Credit Matters Today” March 5, 2007

18. Citigroup Risk Management PrioritiesDave Bushnell - 2005 • The need to balance effectively between risk and reward • The real key to superior performance is to effectively manage risk, not try to eliminate it • “No” is an unacceptable answer when evaluating the commitment of resources to a new project (deal). “No, because…” and “Yes, if…” are much better answers • Changes in management’s appetite for and approach to the management of risk in recent years have been focused on operational risk, not market or credit risk • As long as management is making the right specific (local) risk related decisions, global risk is a manageable task

19. Citigroup Risk Management PrioritiesDave Bushnell - 2005 • Risk has come to be seen increasingly as a profession…at the same time the firm is trying to rotate people from the businesses in an out of the risk function • Citi personnel have to date simply not been equipped for what Citi is today, and for how different their responsibilities are in terms of safeguarding the firm’s reputation

20. Citigroup Risk Management PrioritiesJessica Palmer – January, 2006 • Suitability will be an ever-important issue going forward • Hedge Funds moving into Asia and we may not have proper margin monitoring system in place. Get ready for growth or don't participate • Derivatives: new initiative by lawyers to say banks were "aiding and abetting" helping client to hide issues which may have been illegal. Client claims he didn't understand the deal and the blame falls totally on the bank that structured the transaction. • ……or "you structured a deal that I really didn't understand or realize I was breaking the law when we transacted it, so it's your fault not mine."

21. Citigroup Risk Management PrioritiesBebe Duke – January, 2007 • Suitability is the key risk issue • Market products are critical for revenue growth • - commodities • - credit derivatives • - "bespoke" interest rate derivatives and "exotics" • Need to raise awareness that the only way to make money is to how to get to the yes. • Client First Initiative

22. Citi’s Capital and Capital Models ROEC / RORC Risk Accounting and Models Regulatory – MIFID Basel II Risk Aversion Risk “Lite” / Relaxed Credit Process Liquidity SME Risk Business vs Independent Risk Balance CDS – Fiduciary and Ops Risk Hedge Funds Complacency Opportunity Cost Political Risk Global Portfolio Citi “Swings” Globalization of Markets Compliance Systems Advanced Risk IssuesSunday, 4 March – Participants’ Concerns

23. Advanced Risk IssuesCourse Overview Basic Credit Risk Analysis • Industry Structure and Company Risk Analysis • Balancing Business Risk and Financial Risk (Key Success Factor Exercise) • Identifying Winners and Losers. • Early Warning Signs / Problem Recognition • Avon Pharmaceutical Case

24. Advanced Risk IssuesCourse Overview Assessing management ability, business strategy, and controls - and the issue of “who’s fault is it?” • Management Competence and Business Strategy (Corning Case) • Business Controls (Citibank Dublin Case)

25. Advanced Risk IssuesCourse Overview Deal Structure and Risk - Poland A2 Motorway Case Converging Risk Issues – Credit Risk, Market Risk, Country Risk, Derivatives Risk How Does Citi “do risk”? • Underwriting risk and conflict management • Market risk / Convergence Risk • Global portfolio management • Operational risk • Country risk

26. Advanced Risk Issues Presentations to Illustrate “How Citi Manages Risk” • CIB Risk Management – Colin Church • Global Portfolio Management – Bill Hartmann • Market Risk / Convergence Risk – Dominic Wallace • Operational Risk – Jaidev Iyer • Country Risk - Doug Smee • Banking in Turkey and EMEA – Steve Bideshi • Problem Recognition / Early Warning Signs - Austin Erwin • Derivatives Risk – Patrick Pancoast • Conflict Management / Franchise Risk – Rashmini Yogaratnam

27. Advanced Risk IssuesQuotes of the Week • Anything that could possibly happen has already happened to us • Jaidev Iyer • Active portfolio management, which has been discussed for years, in now an industry-wide activity • Bill Hartmann • Is it marked to market or marked to guess? • Patrick Pancoast • Don’t mix high business risk with high financial risk • Arnie Ziegel • History tells us that we are creating tomorrow’s problems today • Bill Hartmann • If you every hear the word “miracle”, it’s time to sell • Doug Smee • We are all able to put the client first more readily • Rashmini Yogaratnam

28. Advanced Risk IssuesQuotes of the Week • If you’re a sophisticated fixed income investor, you care about what happens to your investment in the event of a default • Bill Hartmann • If the numbers you see are scaring you, then you should be really scared about the numbers you don’t see • Doug Smee • It is not possible to do a rigorous statistical stress test. We underestimate the probability of very large events • Dominic Wallace • There are three types of client objectives: Non-selective risk reduction, opportunistic risk adjustment, image enhancement • Patrick Pancoast • It’s not just KYC, think about who you’re selling to… • Rashmini Yogaratnam

29. Advanced Risk IssuesQuotes of the Week • Many or most major business problems or losses are the result of a flawed business strategy • Arnie Ziegel, Jaidev Iyer • How do you deal with transparency issues in a country like Russia? • Steve Badeshi • How many lawsuits are there every year against Citigroup by employees? • Jaidev Iyer • The concept of “originate and distribute” is now beginning to be reflected in our portfolio loss performance statistics • Austin Erwin • We can still grow the business even if we face an economic downturn • Steve Badeshi • Risk is holistic • Colin Church • The secondary loan market is a market by appointment • Bill Hartmann

30. Advanced Risk IssuesQuotes of the Week • Companies go bankrupt because they 1) run out of cash, 2) fear that they’ll run out of cash, or 3) their suppliers of liquidity fear that they’ll run out of cash • Arnie Ziegel • Citigroup has the ability to take risk greater than any other financial institution in the world • Colin Church • Whose fault is it? You gave me the money / let me do it / told me to do the trade • Arnie Ziegel • The Unknown, Unknowns • Dominic Wallace • This is not so much about the management of risk, but the management of a business in a risk adjusted manner • Jaidev Iyer • We’re held to a different standard • Rashmini Yogaratnam • No longer should we love assets! • Steve Bideshi

31. Advanced Risk IssuesQuotes of the Week • Bankers and Clients often rationalize away the signs of weakness • Austin Erwin • The longer nothing happens here, the trap just keeps getting tighter and tighter • Colin Church • Investors look at us like a giant warehouse • Bill Hartmann • The known unknowns, unknown unknowns • Dominic Wallace • We very rarely turn down deals outright, we try to figure out how to get them done • Rashmini Yogaratnam • By identifying early we both protect the balance sheet and create opportunities • Austin Erwin • The market is willing to pay for diversification • Bill Hartmann • We do too much too late, after doing too little too early • Doug Smee

32. Advanced Risk Issues Quotes of the Week • Credit Risk Managers tend to be client experts, while market risk managers tend to be product experts • Dominic Wallace • Anything that is unsustainable will end. The longer it takes to end, the bigger the crash will be when it happens. • Doug Smee • The people who should be saying no are saying yes, and the people who should be saying yes are saying no • Dominic Wallace • Do not try to rationalize away increasing danger signals – instead, try to find out why. • Doug Smee • Chuck Prince doesn’t want Tom Maheras to lose more than $100 million on a bad day. • Dominic Wallace • It’s not just about risk management anymore, it’s about capital management • Bill Hartmann • We love you, we love you, we love you……….. we hate you • Bill Hartmann

33. Advanced Risk Issues Themes from the week….. • Credit Risk is becoming a Traded Product • Effective Risk Management is a tool for business growth • The banking industry model is changing from “originate and hold” to “originate and distribute the asset or the risk” • Most deals involve one or more elements of Operational Risk, Franchise Risk, Market Risk and Credit Risk – the boundaries are evaporating, risks are converging • Suitability and Appropriateness are increasingly becoming major risk factors

34. Advanced Risk IssuesThemes from the week….. • Growing complexity of the business is accelerating and inevitable • Reputation risk and Franchise risk are inherent in almost every business activity of Citigroup • Every aspect of our business has potential of creating a loss due to an execution problem in the system • Good planning and risk identification can minimize the over-reaction to a risk event and the potential impairment of the value of a particular franchise

35. Advanced Risk Issues Themes from the week….. • Don’t add Financial Risk where there is high Business Risk - industry and business risk drives a company’s capital structure • Choose clients carefully • Many business problems arise from inadequate, inappropriate, or ill managed strategies • Citigroup is held to a higher standard, and not expected to “aid or abet” improper or inappropriate loans, investments, trades, etc.

36. Advanced Risk Issues -Themes from the week….. • Active portfolio management mitigates portfolio risk • Citi has multiple constituents when considering risk – issuers, investors, regulators, rating agencies • Skepticism is an inherent part of risk assessment • Why do smart bankers sometimes do things that, in retrospect, just don’t make sense?

37. Advanced Risk IssuesBankers and Risk Management • Bankers Manage Client Relationships in order to provide insight, early warning, and preferred positioning • Bankers are Advocates – For Issuers and Investors • Bankers must be Client Advisors rather than Responders • Bankers must be Skeptics (Seeing Around Corners) • Bankers are Responsible to Multiple Constituencies: • shareholders • clients • regulators • Investors

38. Why Were We Here? • Excellent risk management creates shareholder value and can be a major driver of high quality revenue growth • Excellent risk management for revenue growth requires: • “Seeing around corners” - finding risk where we didn’t know or think it existed, and the convergence of types of risks • Skepticism to balance risk with the need to generate revenue growth • Identifying potential flaws of business strategies – internal and clients • A framework for choosing clients very carefully • Understanding the increasing complexity of products

39. Why Were We Here? Excellent risk management for revenue growth requires: • Understanding the reputation and franchise implications of business decisions • Understanding that we will never see all risks, so we • Structure away from risk • Choose clients carefully • Pursue active portfolio management • Create and maintain a superb control culture and business culture • Create and maintain systems for monitoring risk

40. Why Were We Here? • To review how Citigroup is managing risk, including active portfolio management and reputation / franchise risk • Growth demands MORE risk and MORE reward, and it’s up to you to get the balance right • We can grow and still “stick to the fundamentals”, often using new means of distributing risk • To remind you that excellent bankers don’t hesitate to say “I’m sorry, but I just don’t understand….” • To recognize that we’re held to a higher standard, not just because Citi is big, but because Citi is the leader……………

41. Advanced Risk Issues 2007 Seeing Around Corners Revenue Growth and Risk Management in a Complex Global Bank

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