[Op-Ed] Quality of Capital

In November last year, Citigroup’s stock price fell a whopping 26 percent in one day and 50 percent over a week due to fears over worsening financial structure. After the news broke out, Saudi Arabian Prince Alwaleed bin Talal, the bank’s largest individual shareholder, said he would increase his stake from four percent to five percent. On if he would invest again if Citigroup required additional government money, he confidently said he would, saying, “This is cherry on the cream and we will take it.” Citigroup’s stock price has kept falling, however.

After the U.S. government announced that it would nationalize Citigroup by converting its preferred stake in the cash-strapped group to common stock, Alwaleed also decided to exchange his preferred stock for common shares. Preferred stock carries no voting rights but is superior to common stock in the payment of dividends. If his preferred stock is converted to common, he cannot receive 11 percent in dividends. He also cannot enjoy special investor care under which many top Citigroup executives have visited Saudi Arabia to talk to him. If preferred stock is exchanged for common stock, the stake of existing common shareholders will fall from 100 percent to 26 percent. The change has been reflected in Citigroup’s stock price plunge after the government’s announcement of nationalization.

Citigroup’s BIS capital ratio stood at 15.6 percent late last year, higher than the industry average. Also, its tier I ratio, the ratio of a bank’s core equity capital to its risk-weighted assets, is 11.9 percent, higher than the nine percent recommended by the government. Citigroup is the biggest global bank in capital amount, but the quality of its capital has worsened. For example, the share of capital funded by common stock has sharply decreased. In the midst of unexpected challenges, stock prices have fallen and subsequently weakened Citigroup’s capital strength, leading to more jitters among investors.

In response to criticism that existing indicators have failed to evaluate the quality of capital, the U.S. Treasury Department will employ Treasury Communications Enterprise, which evaluates the value of capital depending on common stock, not preferred stock, as a new standard. If Washington sets the rules for the enterprise, major financial institutions should also draw private capital in line with the regulations. If they fail to draw private capital, the government should inject money. Given that, the U.S. financial industry is expected to undergo continuous change.

Editorial Writer Hong Kwon-hee (konihong@donga.com)