Citibank 2014 Annual Report Download - page 119

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Price Risk
Price risk losses arise from fluctuations in the market value of non-trading
and trading positions resulting from changes in interest rates, credit
spreads, foreign exchange rates, equity and commodity prices, and in their
implied volatilities.
Price Risk Measurement and Stress Testing
Price risks are measured in accordance with established standards to
ensure consistency across businesses and the ability to aggregate risk. The
measurements used for non-trading and trading portfolios, as well as
associated stress testing processes, are described below.
Price Risk—Non-Trading Portfolios
Net Interest Revenue and Interest Rate Risk
Net interest revenue, for interest rate exposure purposes, is the difference
between the yield earned on the non-trading portfolio assets (including
customer loans) and the rate paid on the liabilities (including customer
deposits or company borrowings). Net interest revenue is affected by changes
in the level of interest rates, as well as the amounts of assets and liabilities,
and the timing of repricing of assets and liabilities to reflect market rates.
Interest Rate Risk Measurement—IRE
Citi’s principal measure of risk to net interest revenue is interest rate
exposure (IRE). IRE measures the change in expected net interest revenue
in each currency resulting solely from unanticipated changes in forward
interest rates.
Citi’s estimated IRE incorporates various assumptions including
prepayment rates on loans, customer behavior, and the impact of pricing
decisions. For example, in rising interest rate scenarios, portions of the
deposit portfolio may be assumed to experience rate increases that are less
than the change in market interest rates. In declining interest rate scenarios,
it is assumed that mortgage portfolios experience higher prepayment rates.
IRE assumes that businesses and/or Citi Treasury make no additional
changes in balances or positioning in response to the unanticipated
rate changes.
Mitigation and Hedging of Interest Rate Risk
In order to manage changes in interest rates effectively, Citi may modify
pricing on new customer loans and deposits, purchase fixed rate securities,
issue debt that is either fixed or floating or enter into derivative transactions
that have the opposite risk exposures. Citi regularly assesses the viability of
these and other strategies to reduce its interest rate risks and implements
such strategies when it believes those actions are prudent.
Citi manages interest rate risk as a consolidated company-wide position.
Citi’s client-facing businesses create interest rate sensitive positions,
including loans and deposits, as part of their ongoing activities. Citi Treasury
aggregates these risk positions and manages them centrally. Operating within
established limits, Citi Treasury makes positioning decisions and uses tools,
such as Citi’s investment securities portfolio, company-issued debt, and
interest rate derivatives, to target the desired risk profile. Changes in Citi’s
interest rate risk position reflect the accumulated changes in all non-trading
assets and liabilities, with potentially large and offsetting impacts, as well as
Citi Treasury’s positioning decisions.
Stress Testing
Citigroup employs additional measurements, including stress testing the
impact of non-linear interest rate movements on the value of the balance
sheet; the analysis of portfolio duration and volatility, particularly as they
relate to mortgage loans and mortgage-backed securities; and the potential
impact of the change in the spread between different market indices.
Interest Rate Risk Measurement—OCI at Risk
Citi also measures the potential impacts of changes in interest rates on the
value of its Other Comprehensive Income (OCI), which can in turn impact
Citi’s Common Equity Tier 1 Capital ratio. Citi’s goal is to benefit from an
increase in the market level of interest rates, while limiting the impact of
changes in OCI on its regulatory capital position.
OCI at risk is managed as part of the company-wide interest rate
risk position. OCI at risk considers potential changes in OCI (and the
corresponding impact on the Common Equity Tier 1 Capital ratio) relative to
Citi’s capital generation capacity.