In the last few years, big American banks have left few stones unturned, and few continents unexplored, in their search for new revenue streams: Post financial-crash regulation has forced them to. But, of all the places you'd expect them to find a new source of revenue, crisis-ridden, recession-plagued Europe is probably the last. But that's exactly what Citigroup (NYSE: C ) has done.
The art, and profit, of the commodity deal
Financial Times is reporting that the super bank is hopping the pond to open a commodity-trade-finance business there. As the name suggests, commodity-trade finance helps trading houses that deal in commodities -- be it corn, coffee, or precious metals -- finance their deals. Since commodity-trading houses tend to be lightly capitalized, this is a critical service, especially for big deals.
Say a trader wants to purchase $100 million worth of soy beans in the hopes of finding a buyer later. A bank will step in, fund the deal, and carry the $100 million on its balance sheet until the trader can find a buyer and make the sale. The bank then collects a tidy profit on the deal. It's a simple, straightforward way to make money: potentially, quite a lot of it.
According to Kris Van Broekhoven, the Deutsche Bank (NYSE: DB ) executive Citi poached to head up the new unit, the bank expects to make $300 million in net profit from commodity-trade financing over the next three years. Nothing to sneeze at, even for a leviathan like Citi.
One regulation to rule them all
For starters, Citi says it will stick to financing energy deals, eventually moving into other, more typical commodities. That's smart: Move slowly, learn the business, then scale up. Clearly, this enterprise has been thought through on Citi's end, which isn't always the case when a business decides to try something new.
And new is the name of the game right now in banking. It has to be. The 2010 Dodd-Frank banking legislation changed everything. Even the old-line investment banks have started to move back into safer, more traditional lines of business. Goldman Sachs (NYSE: GS ) and Morgan Stanley (NYSE: MS ) recently have opened private banks-within-banks to provide their wealthy clients with basic banking services, like home loans.
This is all good news for a U.S. banking system, and a world economy, that was nearly shattered in the financial crash. And it's primarily due to a simple, key piece of regulation that provided a needed push: the Volcker Rule.
Part of the generally unwieldy and overly complex Dodd-Frank, the Volcker Rule states that banks may no longer engage in proprietary trading: that is, trade with their own money for their own gain. While not perfect, and open to perhaps a bit too much interpretation (witness JPMorgan Chase (NYSE: JPM ) and the infamous London Whale trading debacle: Was it a hedge or a speculative bet?), it still seems to be having the desired effect. To wit, banks are shutting down their proprietary trading operations and finding new revenue streams, like private banking, or in the case of Citigroup, commodity-trade financing.
Europe's loss is Citi's gain
Citi has this golden opportunity in the European commodity-trade financing market due to the pullback of previously entrenched continental lenders, who are now too financially occupied with building up their capital cushions a la Basel III, the most recent set of world banking rules, to do much of anything else. But, Basel III aside, anyone who's picked up a newspaper in the last three years knows Europe's banks are just struggling, period: Hence, European businesses are more in need of financing than ever.
And who better to provide that financing than Citigroup, a bank-investor favorite. Citi still has a long way to go to pull itself out of the hole it dug itself into in the run-up to the financial crash, but moving back to more of a traditional banking model could be the start. Who knows, maybe someday Citi will be straightforward enough in its operations and dealings that investors can buy shares and more-or-less know what they're getting. But, that's not right now.
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