Citibank 2012 Annual Report Download - page 93

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Citi May Incur Significant Losses If Its Risk Management
Processes and Strategies Are Ineffective, and Concentration
of Risk Increases the Potential for Such Losses.
Citi’s independent risk management organization is structured so as to
facilitate the management of the principal risks Citi assumes in conducting
its activities—credit risk, market risk and operational risk—across three
dimensions: businesses, regions and critical products. Credit risk is the
potential for financial loss resulting from the failure of a borrower or
counterparty to honor its financial or contractual obligations. Market risk
encompasses both liquidity risk and price risk. For a discussion of funding
and liquidity risk, see “Capital Resources and Liquidity—Funding and
Liquidity” and “Risk Factors—Liquidity Risks” above. Price risk losses
arise from fluctuations in the market value of trading and non-trading
positions resulting from changes in interest rates, credit spreads, foreign
exchange rates, equity and commodity prices and in their implied volatilities.
Operational risk is the risk for loss resulting from inadequate or failed
internal processes, systems or human factors, or from external events, and
includes reputation and franchise risk associated with business practices
or market conduct in which Citi is involved. For additional information on
each of these areas of risk as well as risk management at Citi, including
management review processes and structure, see “Managing Global Risk”
below. Managing these risks is made especially challenging within a
global and complex financial institution such as Citi, particularly given
the complex and diverse financial markets and rapidly evolving market
conditions in which Citi operates.
Citi employs a broad and diversified set of risk management and
mitigation processes and strategies, including the use of various risk models,
in analyzing and monitoring these and other risk categories. However, these
models, processes and strategies are inherently limited because they involve
techniques, including the use of historical data in some circumstances, and
judgments that cannot anticipate every economic and financial outcome in
the markets in which it operates nor can it anticipate the specifics and timing
of such outcomes. Citi could incur significant losses if its risk management
processes, strategies or models are ineffective in properly anticipating or
managing these risks.
In addition, concentrations of risk, particularly credit and market risk,
can further increase the risk of significant losses. At December 31, 2012, Citi’s
most significant concentration of credit risk was with the U.S. government
and its agencies, which primarily results from trading assets and investments
issued by the U.S. government and its agencies. Citi also routinely executes
a high volume of securities, trading, derivative and foreign exchange
transactions with counterparties in the financial services sector, including
banks, other financial institutions, insurance companies, investment banks
and government and central banks. To the extent regulatory or market
developments lead to an increased centralization of trading activity through
particular clearing houses, central agents or exchanges, this could increase
Citi’s concentration of risk in this sector. Concentrations of risk can limit, and
have limited, the effectiveness of Citi’s hedging strategies and have caused
Citi to incur significant losses, and they may do so again in the future.