KGB: Stephen Roberts

Citi's Australian and New Zealand country officer says the breakup of the euro isn't likely, although the wholesale funding market is damaged, while his company has become 'completely different' since the GFC.

Citi chief country officer for Australian and New Zealand, Stephen Roberts tells Business Spectator's Robert Gottliebsen and Stephen Bartholomeusz:

There is the capability within Europe to fix Europe and the worst case scenario – the break up of the euro – is not likely to happen.

Wholesale funding markets are damaged and although they will hurt European banks, Australian and other global financial institutions will not be hit hard.

Citi is a completely different organisation to what it was back in 2008-09 as it has returned to the basics of banking and has far greater capital strength.

He would not talk about JP Morgan's recent $2 billion loss, but said Citi only does intermediate risk and regulation in the area is increasing.

Citi has increased its market share mostly because it has put together a great team of people.

Citi has realised its goal of becoming a major retail operator in Australia.

Stephen Bartholomeusz: Stephen, when last we spoke to you I think it was in October 2008, and the world was heading into something really dark and dangerous, it seems like dj vu. This time it’s Europe of course, not the GFC. What’s your view of the best case, worst case outcome from what’s going on in Europe?

Stephen Roberts: Well, that’s a tough one. Firstly, look, it is a little bit like dj vu, Steve, and I think the only difference that I would say is that it’s part of the same process. What we’re seeing taking place in Europe today is very much along the same lines as what took place in the United States four, five years ago and that’s a fundamental deleveraging at an individual level, at a corporate level and at a government level. So it’s going to take a while to play out.

The best case scenario candidly today is probably just stability. I think what the market is looking for is just a decrease in the volatility and to get that however is going to require some pretty serious action by both European politicians and bureaucrats. That’s the best case scenario. Clearly I don’t even want to think about what a worst case scenario is. That clearly comprises a mixture of a breakup of the euro which has significant implications on global financial services obviously, sovereign debt and so on. Candidly though my view is that there is the capability within Europe to fix Europe and I think that there are a lot of very smart people dedicated to that process today.

The question that everybody is asking themselves is: is there the willpower to be able to create that stability to see a long-term, sustainable euro? And the answer really I think to that is yes, but in the near term we will see volatility. Everybody of course is looking to this weekend to see what the results of the Greek election will be. It’s very interesting. There is a really mixed view as to what people desire.

I’ve spoken to people in fact this morning whose view is they would like to see a Greek government elected which would support extracting the country from the euro, get it over with and move on and make sure that all the resources are then dedicated to ensuring that the other countries which are vulnerable will actually survive. Of course on the other hand those that seek stability would like to see a government in Greece that will work hard at austerity to maintain its presence in the euro. So, everybody is focused on Greece this weekend. The best case scenario is stability. The worst case scenario, which I don’t think will happen, is they break up. So as I said, I think there are a lot of smart people working on it and I think they have the capability within Europe to fix it, but timing and volatility are working against them.

Robert Gottliebsen: Stephen, behind this crisis are a series of banks that have incurred substantial losses and those losses have not been recognised in their public statements. When those losses are recognised, what effect does the necessary recapitalisation have on the total world banking system?

SR: Look, I think clearly there is a serious implication for the realisation of all the exposure of the European financial institutions, but as I said in my earlier comments, I do think within Europe there is the ability to fix Europe and that includes obviously recapitalisation of some very, very, very troubled financial services’ balance sheets.

In terms of its impact on the global financial services infrastructure, candidly in the scenario where we do seek stability and we do see recapitalisation I don’t think the flow-on effect to the world’s banks is going to be as great. So yes, I do see it being a negative for European financial services for a long time, but I don’t see it being a tidal wave affecting the entire global financial services sector because I think there is an inherent strength in the rest of the world’s banks which will hedge us against that.

RG: I’m particularly concerned about the wholesale market that our banks tap to fund their loans. Do you think that wholesale market could be damaged even on a good scenario?

SR: Look , it is damaged. It’s clearly damaged already, Rob. I think that the price spreads that wholesale markets are providing funding for global financial services has already increased dramatically. I think there is already an implicit pricing which has gone into the cost of funding for banks. I don’t however see that having a disastrous impact on certainly Australian banks and many of the world’s financial institutions. There are a number of alternative sources of funding and I don’t see the malaise in Europe necessarily causing catastrophe, certainly down here and any other parts of the world in the financial services sector.

SB: Stephen, back in 2008 the interbank market basically froze because no one could trust each other. Are you saying that since then the US banks, the Australian banks, non-European banks have sufficiently quarantined Europe so it won’t be a major issue globally?

SR: I do think that, yes, what took place in 2008, the resilience of the Australian financial services sector, the rebound in the US financial services sector and the strength of Asian banks will be sufficient to insulate them from a lot of what volatility and crisis will take place within their counterparts in Europe. I do not see a situation where we are seeing a global freeze out of both interbank lending and financing for banks generally.

RG: That’s a big change, isn’t it, from 2008, 2009?

SR: I think it is a big change. I think that as a result of what took place in 2007 through 2009, what is taking place in the regulatory environment, is providing that insulation. That of course is assuming we don’t see the worst case scenario. We see an outcome as I would hope which will be a return to some stability. So, clearly in a crisis situation where everything is falling off a cliff I don’t even want to speculate as to what may happen then, but I can’t see that scenario arriving.

RG: But if we did get that scenario, then we’d almost certainly see a repeat of what we saw in 2008, 2009 with the market freezing.

SR: I don’t know that we would. I think that you would see, because we experienced and learned many lessons in 2008, 2009, the public sector, governments around the world act in such a manner to avoid some of those potential damages that were going to take place in 2008, 2009, so I do not see a return to that Armageddon scenario.

SB: Stephen, one of the most substantial changes between that period of 2008 and today is the state of the US banking system. The stress tests in the US were real whereas in Europe they were a charade. It is remarkable, isn’t it, how much stronger the banking system is in the States is now than it was and how much weaker the European system is than it was?

SR: I’d certainly agree with that. I think that one of the things certainly having lived through it in 2008, 2009, the US banking system and the US generally undertook a period of disclosure much more quickly and tried to address the problem very, very quickly and get back onto a normal footing. Clearly the longer that a lack of disclosure takes place, the worse the problem gets and that’s where I see the difference. And of course in other parts of the world, certainly in this time zone, certainly in this country, there is a very, very, very powerful resilience within the financial services sector which is why I do not see a global but negative downturn of such dramatic impact. Clearly all economies will be affected and insofar as that may affect some returns in banks, the margins, funding costs and so on, yes that will take place, but I do not see a disaster scenario as a result of the resilience both in the US, Asia and certainly Australia, other parts of North America.

SB: Can you tell us a little bit about how different Citi both globally and in Australia is today to what it was back then?

SR: Oh , totally different. So many things have changed. You know, clearly a lot of lessons have been learned. I think probably the biggest change for the company is going back to the basics of banking in terms of responsible finance, ensuring it’s of economic, fundamental economic benefit, a service to clients and a service to the community. Clearly also the bank has become a lot more efficient. It’s become a lot fitter. Its capital strength is much more significant. So, it’s a completely different organisation to that which existed several years ago. And that manifests itself in both the balance sheet strength of the institution, but also the culture of the institution. So, it’s an area that’s impacted every part of the bank, every individual in the bank, the way we do business, the clients that we do business with and how we do it. So, the impact has been enormous.

RG: Stephen, do you think that the weakness in the American banking system is the over-reliance of many of the very big Wall Street banks on trading for their income and that one of the challenges of whoever takes over as president in 2013 will be to consider whether to split trading off from conventional banking?

SR: No. Look, I don’t necessarily agree with that. I think clearly it is the role of banks to take risk in some way, shape or form and I don’t see the fact that banks have a trading business is necessarily a weakness. It is entirely of course a function of how that risk is managed. But trading is but one aspect of a financial service that the banks provide to clients. Clearly our clients are comprised of every type or member of community, from individuals through to large corporations, institutional investors and our role in society is fundamentally one of intermediating capital flows and trading is a part of that. So I don’t see that necessarily being completely carved out of the industry.

Clearly there is a lot taking place, a lot of debate taking place within the United States at the moment as to what extent that should be part of the banks and there clearly will be an increased level of regulation over that activity, but I still believe that it is a fundamental service within the provision of a broader financial services infrastructure that we provide all of our clients, so I don’t see it necessarily being completely removed from the functionality of the banks in the US.

RG: But the $2 billion JP Morgan loss and the circumstances of that loss show that at least that organisation was extending way beyond just offsetting client risks and doing. It was in the gambling, punting business.

SR: Oh look, I'm not obviously in a position to talk to whatever took place at JP Morgan. You know, as I said, the banks all take a degree of risk in the business that we do. That’s what we do is intermediate risk. Certainly I can speak to our own liquidity portfolio if you like and that at the moment is comprised of about 50 per cent cash and 90 per cent of the remainder is comprised of US government and semi-government securities.

So, from a risk perspective it’s very low and I can also obviously reinforce that our trading activities are done with a very, very high degree of risk and regulatory oversight. But again I get back to the point that the banks are in the business of intermediating capital and taking risk and I don’t see that ever going, but I do see there being an increased level of regulation and I do see the risk parameters around those activities being significantly increased, including obviously through the implementation of the Basel III regulations over the course of the next few years.

SB: Stephen, can we take from that that given that the sort of scale of financial flows through the system and the volatility of them, that from time to time no matter how good your controls, no matter how conservative the settings those banks who operate globally and conduct traffic activity are going to have sort of aberrative moments?

SR: Inevitably in the course of taking risk there will be losses. In every activity that we undertake clearly we provide reserves for those activities. We hope that the reserves that we take are commensurate with the risks that we take, but inherent in risk is a level of uncertainty about how those should be measured and how those should be treated, but I certainly don’t agree that there is an inevitability of severe loss or enormous volatility in the taking of risk. It’s a function really of how it’s controlled, how it’s regulated, how it’s measured and I think that certainly within this organisation we feel very comfortable with the way that’s currently being managed.

RG: If I could bring you to Australia. Is the Reserve Bank taking a fairly tough line to make sure that the overseas banks who operate here have their own capital base here in this country and supporting their deposit base or are they more than happy just to let the parent company guarantee go through?

SR: No. I mean certainly the regulatory environment down here is and it has been demonstrated to be effective through its success over the last several years, the regulators that we report to here in Australia both the Reserve Bank, APRA as it relates to prudential standards and of course ASIC in terms of securities do ensure that we are well capitalised independently of our parents. So, for example, our balance sheet here in Australia is pretty much entirely locally funded. We have a very, very strong capital base in terms of tier one capital of somewhere between 24 to 25 per cent. So, the Reserve Bank and the overall regulatory community down here certainly likes to see that banks can operate down here without reliance upon our guarantees from parents overseas.

SB: Stephen, how are you funded and how difficult has it been? Are you involved in for instance in the deposit boards?

SR: We certainly gather deposits in Australia and insofar as there is competition for those deposits we are closely involved, but we fund in Australia through a number of different mechanisms clearly, both to the deposit market, retail and corporate deposits through term funding in the local capital markets, through securitisation, so the funding techniques that we use down here are similar to the other domestic banks and insofar as we are competing for deposits at both the retail and institutional level, we are involved in that competition.

SB: They’re all experiencing margin pressures, you know, low credit volume, growth and so on. Are you seeing the same sort of things?

SR: Certainly. I mean we’re all under margin pressure at the moment. As we mentioned earlier in the conversation, funding costs have gone up and in this great environment there are inevitable margin pressures. But I’m pleased to say that the business down here has done very, very well in the course of the last 12 months, 24 months albeit you could argue off a relatively lower base, but our market share has increased dramatically, our balance sheet is very strong, liquidity is strong, capital is strong and in fact I feel better about our business today than I’ve ever felt before.

RG: What did you do to increase market share?

SR: At the end of the day I think it comes down to people, people and product. Clearly on the retail side of our business we have a number of very competitive strengths in terms of technology, certainly in terms of our cards business, and our mortgage business has been very focused and targeted to a particular part of the market. And on the institutional side of our business I think it really is a function of people and we’ve been very fortunate that over the last couple of years we’ve been able to put together a really first grade team and that now is starting to demonstrate its effectiveness through market share gain.

SB: Stephen, on that institutional stroke investment bank, you had actually put in a whole bunch of new people and you’re now way up the league tables. Has it surprised you how quickly Citi has rebounded?

SR: You know, league tables are an interesting thing. Obviously when we had this conversation a couple of years ago, Stephen, I spoke of the low volumes and our position on the league tables was very much further down the league tables. And whilst we do have a top one, two or three position at the moment in almost everything that we’re doing, clearly we’re only half way through the year. Volumes have been low. Equity capital market transactions have been reduced. Volumes of M and A are slow. But yes candidly I think when I made remarks publically about wanting to be top three, it was in the context of sort of 2013, but there’s a long way to go.

We will continue to aspire to be a top three to five player in this market and hopefully that’s where we’ll be, but I am very pleased with the market share gains that we have made in the last six to twelve months and I will be very happy if we can maintain those. But candidly I think that realistically I don’t expect us to really maintain a top one or two market share position throughout the year and I will be happy slightly below that.

RG: A long time ago, Citibank had ambitions to be a major retail banker in Australia. Is there any possibility that old ambition will be restored?

SR: I think that ambition has actually been realised; I think we are a major retail operator in Australia. And I don’t say that tongue in cheek. I think, clearly in terms of our retail activity our current cards business is perhaps I think fifth at the moment, but approaching the fourth biggest card player in the country. Clearly in mortgages, given the domination of the four domestic banks, it’s harder to gain a significant market share given the proportion of assets that the four majors have dedicated to the mortgage business. But our retail business I think we are a major player in Australia.

We have a brand recognition which I think is higher than our in fact market share would suggest. So, clearly in a market where the top four domestic banks account for 85, 90 per cent of the business it’s difficult to describe yourself as that major retail player, but I honestly believe that in sectors that we do play at I would like to define us as a major player and that’s certainly is I think relevant to our local cards business, retail banking and mortgage business.

SB: Stephen, you refer to the dominance of the big four in housing, in mortgages. Given that house prices have been sliding and there’s been this huge debate about where the housing market is and where it might go, does that make you happy that you’re a small player in that particular market?

SR: Look, we’re very focused in terms of our mortgage activity. But candidly we are not as concerned I think about softening in real estate prices. I think the expectation that there was a residential mortgage bubble in Australia I think has been proven to be probably incorrect. There has been a softening in real estate pricing in Australia, but the market still remains strong and the structure of the mortgages in Australia also provides resilience to that sector. So, whilst I would like to have a higher market share in the mortgage business, I’m very comfortable with where our market share is, but I’m also very comfortable with the credit quality of the portfolio and also very comfortable with where housing prices have gone in Australia. So I have no reason to be concerned about that at the moment.

SB: Stephen, Citi is about to or is experiencing its 200th birthday this year, isn’t it? I think I read somewhere recently that the GFC represented the fourth life-threatening crisis in the group’s history. Hopefully it will be another 50 or 100 years before you get the fifth.

SR: One hopes. We are actually celebrating our two hundredth anniversary this week in fact on Saturday, the 16th of June, we will be celebrating globally our 200th anniversary. We’ll also be marking that event significantly here in Australia with a number of both community focused and staff focused events. I hadn’t actually added up that we had four life threatening events, but clearly it’s a cyclical business and given the footprint in which we operate in – we have a presence in more than 100 countries, but I think we do business in about a 160 – there will always be volatility and clearly the cycle that we’ve just gone through is one that certainly no one in our lives has experienced before and it is doubtful whether anyone in our lifetimes will experience again.

But those cycles will take place again and all we can do is learn from them. It was a life-threatening situation for Citi and I can assure you, apropos the earlier answer that I provided, lessons were learned and the company is a very, very different place for it, but it is a cyclical business and there will be volatility again. But candidly I can’t remember the four life-threatening situations, but I’ll certainly go back over our history books and have a look. But we’re very pleased to celebrate it. Two hundred years is a long time to be in the financial services business and I think there are very few institutions that can make the same claim, but we intend to be around for another 200 and I hope it doesn’t take another four, if that is the number, life-threatening events for us to be there.

SB: Stephen, thank you very much indeed for your time. We appreciate it.

RG: Thank you, Stephen.

SR: Thanks, Rob. Thanks, Stephen.

SB: Speak to you again, Stephen.