Copyright © 2004 Citigroup Inc. CITIGROUP and the Umbrella ...

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Copyright © 2004 Citigroup Inc. CITIGROUP and the Umbrella Device are trademarks and service marks of Citicorp or its affiliates and are used and registered throughout the world. Manage Financial Institutions - Credit analytical viewpoint Shinhwa Chou, Vice President Relationship Management, Financial Institutions Group March 16, 2005

Transcript of Copyright © 2004 Citigroup Inc. CITIGROUP and the Umbrella ...

Page 1: Copyright © 2004 Citigroup Inc. CITIGROUP and the Umbrella ...

Copyright © 2004 Citigroup Inc. CITIGROUP and the Umbrella Device are trademarks and service marks of Citicorp or its affiliates and are used and registered throughout the world.

Manage Financial Institutions - Credit analytical viewpoint

Shinhwa Chou, Vice President

Relationship Management, Financial Institutions Group

March 16, 2005

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AgendaAgenda

Analysis of banks & insurance companies– From quantitative point of view

– From qualitative point of view

Industry development trend & focus Strategies & Tactics to become a better FI

– Business Development

– Cost Management

– Risk Management

– Capital Adequacy Management

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How to Analyze Banks

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CAMEL Approach

EEarnings Powerarnings PowerEEarnings Powerarnings Power LLiquidityiquidityLLiquidityiquidity

AAsset Qualitysset QualityAAsset Qualitysset Quality

MManagementanagement

CCapital Adequacyapital Adequacy

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Capital Adequacy

BIS Ratio: Shareholders commitment in absorbing loss from risk assets

Tier 1 + 2 + 3 capital - LT investment without consolidation

Credit risk assets + Capital charge on market risk X 12.5

Tier 1= common stocks, perpetual non-accumulated preferred shares/sub-debts, legal reserves,..etc.

Tier 2= Perpetual accumulated preferred shares/sub-debts, convertible bonds, bad debt reserves, 45% of re-valuation of LT capital gains, sub-debt > 5 yrs …etc.

Tier 3= ST sub-debt, and non perpetual preferred shares

> 10%

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Capital Adequacy

Regulation requirement: BIS ≧ 8%, semi-annual release

Basel II– Will be effective on 2006/12/31– 3-pillar concept– In addition to Credit Risk, Market Risk & Operational Risk are taken into

consideration

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Capital Adequacy

11.17%

10.75%

10.40%

10.63%

10.09%10.01%

10.58%

8.0%

8.5%

9.0%

9.5%

10.0%

10.5%

11.0%

11.5%

12.0%

2004/06 2003/12 2002/12 2001/12 2000/12 1999/12 1998/12

As of 2004/06, Taiwan Banking Sector BIS was 10.01%

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Asset Quality

NPL Ratio: The potential credit cost in risk asset taking

Broad Based (Narrow Based) NPL

Net Loans

< 2.5%

Non Performing Loan (NPL)– International Standard (Broad Based): 90 days PDO (past due obligation)

– MoF Standard (Narrow Based): 180 days PDO

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Asset Quality

How to read NPL Ratio on financial statements

180 Days

90 Days

1.46% 2.25%90D NPL Ratio:

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Asset Quality

7.48%7.12%

6.12%6.11%5.62%

4.33%4.14%

3.54%3.31%

3.80%

11.75%

10.83%

10.17%

8.60%

7.87%

6.08%5.72%

4.52%

5.68%

7.48%

8.04%

11.26%

8.59%

7.97%

5.29%4.89%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

10.0%

11.0%

12.0%

2001/12 2002/06 2002/12 2003/06 2003/12 2004/06 2004/12

180 Day

90 Day

NPL Ratio is improving since 2001.

Industry average is 5.29% as of 2004.

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0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2003/06 2003/09 2003/12 2004/03 2004/06 2004/09 2004/12

NPL <2.5% 2.5%<NPL<5% 5%<NPL<7.5% 7.5%<NPL<10% NPL>10%

Asset Quality

Starting from 2004/03, over 50% banks’ 90D NPL ratio is less than 5%

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Asset Quality

Coverage Ratio: Loss estimation from bad loans

Loan Loss Reserve

Non Performing Loan

> 60%

Reserve adequacy is subject to:– LTV Ratio: Loan / Collateral Value

– Evaluation of collateral

• Appraisal base

• Update frequency

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Asset Quality

Coverage Ratio

90 Days

45.78% 39.67%Coverage Ratio:

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Asset Quality

Coverage ratio

2004

16.33%

57.14%26.53%

<40% 40-60% >60%

2003 2003 Industry Industry Average 23.22%Average 23.22%

2003 2003 Industry Industry Average 23.22%Average 23.22%

2004 2004 Industry Industry Average 30.34%Average 30.34%2004 2004 Industry Industry

Average 30.34%Average 30.34%

20038%

76%

16%

<40% 40-60% >60%

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Earnings Power

ROA > 1%

ROE > 15% ~ 20%

ROA & ROE: Collective return per $1 risk asset taking and $1 shareholder money

A business indicator for assessment of:– Revenue Stream: diversified, sustainable

– Cost Control: credit cost, funding cost, operational cost

– Business Strategy: pricing strategy, loan growth plan

– Financing Strategy: capital structure, Tier 1 capital surplus

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ROA & ROE

2004 Taiwan banking’s avg. ROA:0.61% & avg. ROE:15.71%

-22%

-12%

-2%

8%

18%

28%

38%

48%

-3.0% -2.0% -1.0% 0.0% 1.0% 2.0% 3.0%

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Earnings Power

Efficiency: cost to income ratio (SG&M / EBIT) < 40%

2004 Taiwan banking’s avg. 90.49%

11.90%

38.10%

33.33%

16.67%

<40% 40-80% 80-120% >120%

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Liquidity

Total Net Loans

Total Customer Deposits

Loan to Deposit Ratio: Self-funding capability

Too high or too low, for assessment of:– Efficiency of fund’s flow utilization

– Adequacy of liquidity strain buffer

Funding source consideration– Diversified funding: retail or wholesale

– Sustainable deposit base

– Alternative funding source

≦ 85%

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40%

50%

60%

70%

80%

90%

100%

110%

120%

Liquidity

2004 Taiwan banking’s avg. L/D ratio was 81.94%

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Management - Qualitative point of view

Risk ArchitectureRisk Architecture

Management Reputation

Management Reputation FranchiseFranchise

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Risk Architecture

Credit Risk

Market Risk

Track Recordof Credit

Management

- level of sophistication of a bank’s credit committee - management team’s credit awareness- roles and responsibilities of credit management- systems and infrastructures to detect and manage the risk- the evaluation model to reflect its customer’s credit soundness- the risk profile and the composition of its customers

- analyze whether the bank take appropriate positions and protect against losses that result from market fluctuations, both price and liquidity risk- we evaluate a bank’s risk identification and quantifying capabilitiessuch as market-to-market system, its risk management skills, the limit setting, approval controls, regular reporting, ongoing validation

-The track record reflects how a bank has managed its credit exposure and gives us an idea of where this bank stands in the industry-Also, we can further evaluate whether a better bank can continue its strength

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Management Reputation

IntegrityIntegrityIntegrityIntegrity

Strategic Strategic Vision of Vision of BusinessBusiness

Strategic Strategic Vision of Vision of BusinessBusiness

Execution Execution and and

LeadershipLeadership

Execution Execution and and

LeadershipLeadership

• the bank’s level of compliance with regulations• accounting methods and information disclosure• factors that may influence management integrity ( which include the background and composition of the board members, whether the bank has close relationshipwith local conglomerate, the operation and financial soundness of the conglomerate, the level of professionalism of the team )

• Strategic vision is one of the most important factors in shaping a business and anchoring the direction to which a business is heading. • A sound management team must demonstrate that they know where they are today, where they used to be in the past, and where they want to be in the future.• A sound management also needs to have a clear vision on how the business will be developed and the vision must be successfully implemented in each functionareas, business units, product development, risk management, etc.

• Whether the management team could establish the link between the management of human assets and the bank’s vision and strategies• Whether the bank can realize its competitive advantage through leadership and human resource management all the way from recruitment, selection, training, retention, performance management and evaluation, • Whether the bank could aligning the management system with business goals and the organizational structures.

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Franchise

Scale Scale / Diversification / Diversification

of Businessof Business

Product Product InnovationInnovation

FinancialFinancial FlexibilityFlexibility

• number of branches, • asset size, • number of customers, • deposit and loan portfolio, • power and niche of the franchise and whether the value can be replaceable or replicated by other bank.

• The bank has right people and mechanism to design, sell, and provide after-sales service for new products.• The bank can leverage on other entities to provide new products to clients. • Whether the bank has incentives to motivate the product innovation.• Whether the new products suitable and appropriate for this bank’s client. • Whether the product innovation fit in the bank’s vision and will benefit the bank in the long term.

• Evaluate a bank’s historical financials, the capital structure, the financial instruments it has been using to raise capital.• Evaluate how diversified the instruments are, and how successful each fund-raising was.• Whether a bank is closely followed by foreign brokers and investment companies, including the percentage of foreign FIs holding, how is it rated by international rating agencies.

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Quantitative and Qualitative Assessment

Operating Operating EfficiencyEfficiency

Operating Operating EfficiencyEfficiency

Investment Investment ReturnReturn

Investment Investment ReturnReturn

LiquidityLiquidityLiquidityLiquidity

Key Key Successful Successful

FactorsFactors

Key Key Successful Successful

FactorsFactors

SolvencySolvency

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Solvency

Solvency Ratio

= > 12%

Solvency Ratio

= > 12%

Net Worth

The minimum standard of financial health for life insurance; it is presented by the excess of an insurer’s assets over its liabilities.

The minimum standard of financial health for life insurance; it is presented by the excess of an insurer’s assets over its liabilities.

Taiwanese insurers tend to have lower solvency ratio due to higher required reserves by local regulation. Industry average is 5.59% in 2003.

Taiwanese insurers tend to have lower solvency ratio due to higher required reserves by local regulation. Industry average is 5.59% in 2003.

Life Technical Reserves

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Liquidity

Insurer’s ability to meet claims payments to the policyholders when they are due.

Insurer’s ability to meet claims payments to the policyholders when they are due.

Liquidity Ratio

= > 70%

Liquidity Ratio

= > 70%

Liquid Assets

Technical Reserves

Liquid Assets

= Cash, deposits, and marketable

securities

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Operating Efficiency – Claims Ratio

A rough indicator to evaluate insurers underwriting capability in pricing policy annual premium sufficient to buffer annual claims payments, based on policy actuarial estimation and policy renewal rate maintenance.

A rough indicator to evaluate insurers underwriting capability in pricing policy annual premium sufficient to buffer annual claims payments, based on policy actuarial estimation and policy renewal rate maintenance.

Claims Ratio

= < 90 %

Claims Ratio

= < 90 %

Claims Incurred

Net Written Premium

Net written premium

= Gross written premium – gross written

premium ceded to re-insurers

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Operating Efficiency – Expense Ratio

Expense ratio is to assess insurers’ expenses structure and adequacy of the economy of scale for new policy sale per year

Expense ratio is to assess insurers’ expenses structure and adequacy of the economy of scale for new policy sale per year

Expense Ratio

= < 20 %

Expense Ratio

= < 20 %

Expenses

Net Written Premium

Expenses include general and administration expenses, commission expenses

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Investment Return

Investment return measures insurers’ asset management capability in delivering claims and bonus payments to policyholders as promised in policy guarantee rates

Investment return measures insurers’ asset management capability in delivering claims and bonus payments to policyholders as promised in policy guarantee rates

Investment Return

= >=

Investment Return

= >=

Interest Income

+ Trading Gain

+ Rental Income

Qualified Investment Assets

Averaged Policy

Reserve Rate

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Investment Return – con’t

Investment Asset AllocationInvestment Asset Allocation

Government bonds and foreign investments (mostly in securities) are the two largest asset

classes in portfolio

Government bonds and foreign investments (mostly in securities) are the two largest asset

classes in portfolio

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Key Successful Factors

BrandBrand Reputation ReputationBrandBrand Reputation Reputation The Added value of the brand name image

Investment / Investment / Risk ManagementRisk Management

Investment / Investment / Risk ManagementRisk Management

Ability to match the investment return to the promised rate of return on the policies u/w

Product InnovationProduct InnovationProduct InnovationProduct Innovation Product design to meet economic environment, and policyholders’ needs

Distribution ChannelDistribution ChannelDistribution ChannelDistribution Channel The effectiveness of marketing channels and sales force to deliver new business growth

Operating EfficiencyOperating EfficiencyOperating EfficiencyOperating Efficiency The efficiency of the business operation structure to weather changes in business environment

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Industry Development Trend and Focus

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Deposit Loan Investment Asset Management- Savings - Student loan - Mutual Fund- Checking - Credit Card - Securities

- Mortgage - Structured note- Auto Loan- Personal Loan--- etc.

--- etc.--- etc.

- Insurance.--- etc.

Age

Financial Product Life Cycle

As a matured economy, investment products correspond to social needs

As a matured economy, investment products correspond to social needs

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Optimize Shareholders’ Value

Deliver Promising Deliver Promising ProfitabilityProfitability

Deliver Promising Deliver Promising ProfitabilityProfitability

EPSEPSEPSEPS

Maximize Market Maximize Market CapitalizationCapitalization

Maximize Market Maximize Market CapitalizationCapitalization

Full P/E & P/B Full P/E & P/B MultipleMultiple

Full P/E & P/B Full P/E & P/B MultipleMultiple

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Enhance Franchise Value

Market Share Market Share DominanceDominance / Expansion/ Expansion

Market Share Market Share DominanceDominance / Expansion/ Expansion

Credit Rating Credit Rating UpgradeUpgrade

Credit Rating Credit Rating UpgradeUpgrade

Corporate Corporate GovernanceGovernanceCorporate Corporate

GovernanceGovernance

Acquisition / Acquisition / ConsolidationConsolidation

Organic GrowthOrganic Growth

Acquisition / Acquisition / ConsolidationConsolidation

Organic GrowthOrganic Growth

Risk MgmtRisk Mgmt• Credit riskCredit risk• Market riskMarket risk• Operational Operational riskrisk

Risk MgmtRisk Mgmt• Credit riskCredit risk• Market riskMarket risk• Operational Operational riskrisk

Internal ControlInternal Control• Independent directors Independent directors & supervisors& supervisors• Compliance adherenceCompliance adherence

Info Disclosure Info Disclosure TransparencyTransparency

• Periodic biz update to Periodic biz update to the publicthe public• Financial reporting in Financial reporting in line with int’l standard line with int’l standard

Internal ControlInternal Control• Independent directors Independent directors & supervisors& supervisors• Compliance adherenceCompliance adherence

Info Disclosure Info Disclosure TransparencyTransparency

• Periodic biz update to Periodic biz update to the publicthe public• Financial reporting in Financial reporting in line with int’l standard line with int’l standard

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Strategies & Tactics to Become a Better FI

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A Good Financial Institution

Reflect shareholders’ interest with:– Growth potential

– Growth sustainability

Approach– Business development

– Risk management

– Cost management

– Capital adequacy management

TimeP

erfo

rman

ceTime

Per

form

ance

v.s.

Time

Per

form

ance

Time

Per

form

ance

v.s.

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Business Development

By ProductsBy Products

• Loan / Deposit

• Investments

• FX / Derivatives

• Custody

• Cash Management

• Trade Finance

• Loan / Deposit

• Investments

• FX / Derivatives

• Custody

• Cash Management

• Trade Finance

By CustomersBy Customers

• Individual

• Big corporate

• FI

• SME

• Public sector

• Individual

• Big corporate

• FI

• SME

• Public sector

By ChannelsBy Channels

• Direct Sales

• Branch

• Third Party

• Telemarketing

• DM

• Direct Sales

• Branch

• Third Party

• Telemarketing

• DM

By GeographyBy Geography

• Urban

• Island-wide

• Regional

• Global

• Urban

• Island-wide

• Regional

• Global

Revenue Diversification

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Business Development

Revenue Sustainability– Create customer loyalty (active card usage, low mortgage attrition,

high insurance retention, less frequent redemption, better x-sell ..etc)– Develop appropriate product mix (annuity revenue v.s. deal revenue)– Build cross-sale to same customer base ( finance v.s. investment v.s.

risk hedging)– Build franchise coverage/value

Revenue Growth– New customer / Selective Target Market– New product / Innovation– New market development / penetration– Organic growth vs Inorganic growth (M&A e.g.)

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Business Development

To achieve sustainable revenue growth:– Matrix organization

APCB SME GRB FI Prof. Mkt

- Loan

- Inv. Banking / CM

- FX/Derivatives

- Funding/Gapping

- Custody

- Cash/Trade

Pro

duct

Fam

ily

Business SegmentAPCB SME GRB FI Prof. Mkt

- Loan

- Inv. Banking / CM

- FX/Derivatives

- Funding/Gapping

- Custody

- Cash/Trade

Pro

duct

Fam

ily

Business Segment

Interest Income

Fee Income Trading Income

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Credit Risk Market Risk Other Major Risks

Lending

Direct

Clearing

Issuer

Counterparty

Contingent

Settlement

Pre-settlement

Price

Liquidity

Interest Rates

Stock /Commodity

Currency

Funding

Trading

Country

FiduciaryDocumentation

Political

Transfer/Convertibility

Underwriting

Volatility in Options Disclosure

Legal & Regulatory

FranchiseFraud

ProcessingSystem

Risk Management

Risk Categories

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Credit Risk Management

Asset quality management to achieve the desired Risk /Return– Dynamically diversify credit portfolio by:

• Business segment» Corporate banking, Consumer banking, Investment banking,

Credit card, etc.• Industry

» Industry limit determined by industry life cycle• Customer base• Product

» Trade finance, Securities investment, Bilateral/syndication loan, Mortgage, Credit card, Vehicle loan

• Collateral» Property / Mortgage, PDC, Deposit, Standby LC, Equity,

Chattel, etc.• Geography / Sovereign• Obligor Risk Rating

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Credit Risk Management

Use risk rating methodology to reflect risk level of the credit portfolio

– Scoring method– Forced ranking method

Develop early warning / classification process to proactively monitor the credit quality

Establish control limit within portfolio via segment, product

Establish effective / efficient remedy management process

A required factor for BIS ratio determination under the new Basel Capital Accord

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Market Risk Management

Liquidity Management– Diversified funding sources

• Deposit / interbank borrowing / capital market

• committed v.s. un-committed

• short-term v.s. long-term

– Appropriate liquid asset level

– Dynamic asset/liability management : tenor, interest rate, currency match

– Stress test

Rate Risk Management– VAR / Loss Limit / Sensitivity Limit

– Stop loss discipline

Underwriting / Syndication Risk

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Operation Risk Management

Operational performance– Infrastructure

• System implementation and employee training

• Routinely update infrastructure and maintain its reliability and productivity

– Process efficiency

• Standard procedure enhances efficiency

• Interfaces for optimum access

– Back-up plan

• Business continuity test

Compliance risk– Internal control

– Regulations

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Cost Management

Marketing & Distribution– Measure the effectiveness & efficiency

• Marketing : DM / Advertisement

• Distribution :

» Branch

» ATM or other automation platforms

» Internet

» Telemarketing

» Direct sales / RM / AO

» 3rd party

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Cost Management

Processing– Regionalization / Centralization / Outsourcing– Automation / Straight-through Processing (STP)– ATM, E-trade, on-line insurance, phone-banking– Back-end automation / rationalization – re-engineering– quality projects

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Capital Adequacy

Risk assets requires capital reserve, and capital comes with cost. Therefore, earning power of asset is determined by :

ROA ROE x BIS

Calculate min ROA based on required ROE (IRR), and BIS

Below-than-hurdle ROA will lead to BIS lower than minimum requirement

Control BIS to improve ROE without increasing asset pricing

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Strategies to Improve BIS

Balance SheetBalance SheetBalance SheetBalance Sheet

Assets

Asset Securitization

- Credit Card

- Cash Card

- Mortgage Loan

- Corporate Loan

Fixed Assets (Real Estate)

- Sell & Lease back

- CMBS / REIT

NPL disposal

- Sell down to AMCs

- Securitization

Liabilities Capital Tier

Deposit

- FRN / FRCD

Bond / Debenture

- ST Sub-Debt III

- LT Sub-Debt II

- Convertible Bond II

Equities Capital Tier

Perpetual accumulated

Preferred share II

Hybrid capital note I

Common Stock I

(ADR/GRD)

Financial solutions

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Strategies to Improve BIS

Business model adjustment

NW

Risk Assets

BIS =

Earnings power improvementEarnings power improvement• Cross-sale• Price to risk• Product breadth

Credit portfolio optimizationCredit portfolio optimization

• Credit risk mitigation

• Risk assets reallocation

Risk weight transparencyRisk weight transparency

• Credit risk rating model

Eliminate Market / operational riskEliminate Market / operational risk• Operation outsourcing• Insurance • Hedging

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Q & A

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Copyright © 2004. Citigroup,Inc. All rights reserved. CITIGROUP and the Umbrella Device are trademarks and service marks of Citicorp or its affiliates and are used and registered throughout the world.