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NEW YORK (
Citigroup(C - Get Report) CEO Mike Corbat's focus on
measurable performance metrics such as return on assets and efficiency ratios has been welcomed by shareholders, with the stock extending gains on Wednesday.
But KBW analyst Frederick Cannon points out that the measures, while useful for their simplicity, are not perfect and in fact, could lead to more risk-taking.
Corbat set a return on assets (ROA) target of 0.90% to 1.10% by 2015 and an efficiency ratio- overheads as a percentage of sales- goal for Citigroup as a whole in the mid-50s.
A focus on ROA, however, may create a push for "off balance sheet income," according to the analyst. "Citi has been growing its derivatives business, which is a business with few balance sheet assets, but one that has meaningful risks and needs risk-based capital. An ROA focus could create outsized risk."
Similarly a focus on low efficiency ratios might result in potentially under-investing in less efficient but high returns business. "Many businesses with 80% efficiency ratios but low needs for capital can create high returns," Cannon notes. He cites the example of real estate lending which tends to have lower efficiency ratios than business lending but comes with higher risks.
Efficiency ratios also ignore credit costs and Citi could end up taking more risks in order to achieve efficiencies.
"Overall, we believe that if Mr. Corbat's focus on these goals is not tempered with well-ingrained risk controls, it could lead to a higher-risk Citigroup in the future," said Cannon.
While the presentation did not include a slide on risk management, the analyst noted that Corbat mentioned the need to think about risk of various asset classes.
-- Written by Shanthi Bharatwaj in New York.
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