Citigroup Needs to Spend Money to Make Money

Citigroup


C -4.80%

had a big quarter on Wall Street, and credit costs were much lower. But that probably didn’t matter to many investors.

Instead, many Citi shareholders are focused on the bank’s regulatory woes. Beyond the $400 million penalty imposed by regulators last week, it is not yet clear how much it will cost to resolve the consent order the bank is now operating under. Among other things, the bank will need to invest substantially more in data infrastructure to help its risk management. Dealing with Washington can be costly in general, but technology upgrades at banks can be particularly drawn-out. Before the fine, Citigroup had already disclosed $1 billion in new technology investment for this year, but it hasn’t given specific further figures tied to the consent order.

Some investors might find this frustrating and give up on the stock too soon. Others might be tempted to jump back in once expenses get a bit easier to model. But maybe investors shouldn’t be so focused on expense levels or targets. Coming into the year, for example, Citi didn’t appear to be overly profligate. Its overall efficiency ratio last year—which measures expenses against revenues—at 56.5% was better than big banks overall at 57%, according to Barclays analysts’ industry figures.

Yet that wasn’t mission accomplished, as the bank still had a return-on-equity gap to peers such as JPMorgan Chase. Before the latest regulatory setback, Citigroup did appear on its way to addressing other crucial gaps and catching up to rivals’ returns, such as with a substantial share buyback program and bets on its digital retail bank.

Departing chief executive Michael Corbat told analysts on Tuesday that the bank’s focus on “reducing manual touch points, automating processes and ensuring accurate data can be accessed quickly” will also help “create a digital infrastructure that will make us more efficient, more competitive and significantly improve our ability to serve our clients and customers.” He also acknowledged that in hindsight the bank should have made these upgrades faster “and prevented it from coming to this.”

Quarterly expense numbers will be especially hard to judge as the economy emerges from the pandemic. The bank on Tuesday told analysts that “we could see expenses that are up a couple percent or so on a full year basis.” But it notes that it may see improved profitability going into 2021 and 2022, due in part to expense benefits from things like “capacity adjustments that we may decide to take as we come out of this crisis.”

The question is whether that capacity can or will be replaced by something more efficient—perhaps digital banking that can serve the role of a branch, or an automated loan process to replace a manual one.

For now, it sounds like a lot is being considered. Chief Financial Officer Mark Mason told analysts: “With every crisis in some ways comes a unique opportunity, and that is a unique opportunity to take a hard look at your business model.” That includes the benefit of a new incoming chief executive, Jane Fraser, to “look at our strategy and see what makes sense as we come out of this,” he added.

There are worse fates than being forced to invest in new technology. Citigroup, and its investors, could benefit from a reset.

Write to Telis Demos at telis.demos@wsj.com

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