Citigroup Inc.

MARKET RISKMarket risk encompasses liquidity risk and price risk, both of which arisein the normal course of business of a global financial intermediary. Fora discussion of funding and liquidity risk, see “Capital Resources andLiquidity—Funding and Liquidity” above.Price risk is the earnings risk from changes in interest rates, foreignexchange rates, and equity and commodity prices, and in their impliedvolatilities. Price risk arises in non-trading portfolios, as well as in tradingportfolios.Market risks are measured in accordance with established standardsto ensure consistency across businesses and the ability to aggregate risk.Each business is required to establish, with approval from Citi’s marketrisk management, a market risk limit framework for identified risk factorsthat clearly defines approved risk profiles and is within the parameters ofCitigroup’s overall risk tolerance. In all cases, the businesses are ultimatelyresponsible for the market risks they take and for remaining within theirdefined limits.Non-Trading Portfolios Interest Rate RiskOne of Citigroup’s primary business functions is providing financial productsthat meet the needs of its customers. Loans and deposits are tailored to thecustomers’ requirements with regard to tenor, index (if applicable) and ratetype. Net interest revenue (NIR) is the difference between the yield earned onthe non-trading portfolio assets (including customer loans) and the rate paidon the liabilities (including customer deposits or company borrowings). NIRis affected by changes in the level of interest rates. For example:• At any given time, there may be an unequal amount of assets andliabilities that are subject to market rates due to maturation or repricing.Whenever the amount of liabilities subject to repricing exceeds theamount of assets subject to repricing, a company is considered “liabilitysensitive.” In this case, a company’s NIR will deteriorate in a rising rateenvironment.• The assets and liabilities of a company may reprice at different speeds ormature at different times, subjecting both “liability-sensitive” and “assetsensitive”companies to NIR sensitivity from changing interest rates. Forexample, a company may have a large amount of loans that are subjectto repricing in the current period, but the majority of deposits are notscheduled for repricing until the following period. That company wouldsuffer from NIR deterioration if interest rates were to fall.NIR in the current period is the result of customer transactions andthe related contractual rates originated in prior periods as well as newtransactions in the current period; those prior-period transactions will beimpacted by changes in rates on floating-rate assets and liabilities in thecurrent period.Due to the long-term nature of portfolios, NIR will vary from quarter toquarter even assuming no change in the shape or level of the yield curveas assets and liabilities reprice. These repricings are a function of impliedforward interest rates, which represent the overall market’s estimate of futureinterest rates and incorporate possible changes in the Federal Funds rate aswell as the shape of the yield curve.Interest Rate Risk GovernanceThe risks in Citigroup’s non-traded portfolios are estimated using a commonset of standards that define, measure, limit and report the market risk. Eachbusiness is required to establish, with approval from independent marketrisk management, a market risk limit framework that clearly definesapproved risk profiles and is within the parameters of Citigroup’s overallrisk appetite. In all cases, the businesses are ultimately responsible for themarket risks they take and for remaining within their defined limits. Theselimits are monitored by independent market risk, country and business Assetand Liability Committees and the Global Finance and Asset and LiabilityCommittee.Interest Rate Risk MeasurementCitigroup’s principal measure of risk to NIR is interest rate exposure (IRE).IRE measures the change in expected NIR in each currency resulting solelyfrom unanticipated changes in forward interest rates. Factors such aschanges in volumes, spreads, margins and the impact of prior-period pricingdecisions are not captured by IRE. IRE assumes that businesses make noadditional changes in pricing or balances in response to the unanticipatedrate changes.IRE tests the impact on NIR resulting from unanticipated changes inforward interest rates. For example, if the current 90-day LIBOR rate is3% and the one-year-forward rate is 5% (i.e., the estimated 90-day LIBORrate in one year), the +100 bps IRE scenario measures the impact on thecompany’s NIR of a 100 bps instantaneous change in the 90-day LIBOR to6% in one year.The impact of changing prepayment rates on loan portfolios isincorporated into the results. For example, in the declining interest ratescenarios, it is assumed that mortgage portfolios prepay faster and income isreduced. In addition, in a rising interest rate scenario, portions of the depositportfolio are assumed to experience rate increases that may be less than thechange in market interest rates.117