) recently lowered the set target for its Basel III Tier 1 common
capital ratio from 10% to 9.5%. However, the targeted ratio
remains above the minimum requirement by 50 basis points (bps).
Despite dismal performances over the last two quarters, Citigroup
continued to maintain healthy capital ratios. Considering this,
does the downward revision of the stipulated target indicate
anything wrong in the company's financials?
Actually the decline does not indicate deterioration in
Citigroup's balance sheet. Instead this follows an approval from
the Federal Reserve that allows the bank to adopt Basel III
"advanced approach" to estimate its Risk Weighted Assets (RWAs)
with effect from second-quarter 2014.
In accordance with the advanced approach, Citigroup has to
increase its RWAs from $232 billion to $288 billion. An increase
in RWAs will result in a decline in Tier 1 common capital ratios,
foreseeing which the bank took the latest action.
The Basel III advanced approach is comparatively more flexible
than Basel II standardized approach. So meeting the requirement
of overall higher capital ratios will be easier. Though the
latest approach requires RWAs to be higher, that should primarily
impact the Tier 1 common capital.
Along with Citigroup, other Wall Street biggies like
JPMorgan Chase & Co.
The Goldman Sachs Group, Inc.
) and Morgan Stanley will be resorting to the advanced approach
from second-quarter 2014.
As the banks make a transition from Basel II to Basel III
framework, we observe relaxation of the regulatory bindings to
some extent. However, other mandatory requirements remain the
same and these will likely reduce Citigroup's flexibility with
respect to its business investments.
At present, Citigroup has a Zacks Rank #5 (Strong Sell). This is
because the stock has witnessed significant downward estimate
revisions over the last 30 days on the concerns that the low
interest rate environment, regulatory issues and litigations will
continue to weigh on its financials.
However, the overall situation is not totally bleak. We expect
interest rates to improve in the near term on the back of the
Fed's continuation of tapering.
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