Exclusive-Citi breached a rule meant to keep banks safe, made liquidity reporting errors

By Lananh Nguyen and Tatiana Bautzer

NEW YORK (Reuters) -Citigroup repeatedly breached a U.S. Federal Reserve rule that limits intercompany transactions, leading to errors in its internal liquidity reporting, according to a Citi document from December seen by Reuters.

Reuters is reporting the infractions for the first time. Under so-called Regulation W, banks are required to restrict transactions like loans to the affiliates they control. The rule is meant to protect depositors whose money is insured up to $250,000 by the government.

The Regulation W infractions come as Citi works to fix separate problems in its risk management and internal controls. Authorities labeled its risk practices "unsafe and unsound" in 2020, and rebuked Citi over how it measured counterparty risks in 2023. This year, regulators criticized the bank's resolution planning, and most recently punished it with $136 million in fines for making insufficient progress on compliance.

The firm's "subsequent reaction to the breaches resulted in liquidity reporting inaccuracies," according to the document, which provides a 2023 year-end snapshot of some of Citi's work on regulatory issues.

"We are fully committed to complying with laws and regulations and have a strong Regulation W framework in place to ensure prompt identification, escalation and remediation of issues in a timely manner," a bank spokesperson said.

Reuters could not determine whether the violations have been remedied.

The bank's shares fell 0.7% in Wednesday afternoon trading.

Regulation W was put in place by the Federal Reserve more than two decades ago. It aims to prevent depository institutions from incurring losses from their related entities, known as affiliates, for example by dumping bad assets onto the institution's balance sheet or striking deals at preferential rates.

According to the document, the "longstanding breaches revealed weaknesses" in Citi's "ability to identify, monitor, and prevent" future Regulation W violations. Meanwhile, "proposed revisions to policies and procedures do not appear to provide sufficiently clear guidance for employees to assure compliance with the regulation."

Regulation W violations at Citi were also confirmed by a separate source with direct knowledge of similar infractions who had not reviewed the document. The source requested anonymity because they were not authorized to speak on the record.

The Federal Reserve declined to comment. The Office of the Comptroller of the Currency (OCC) said it does not comment on specific banks.

PROTECTING BANKS

Government examiners test banks on their compliance with Regulation W. Lenders that break the rule can be subject to more scrutiny and fines, compliance experts said. For Citi, which has been under the regulatory spotlight for deficiencies in its risk management and controls since late 2020, any further action could add to its woes.

Citi's Regulation W transgressions were categorized as a compliance risk in the document, and more narrowly labeled as a prudential and regulatory risk. The internal classifications are used by the company to meet global banking standards, according to a source familiar with the document's contents.

The breaches, which happened "over an extended period of time," related to an inter-affiliate clearing relationship, the document said. Clearing refers to the process of reconciling or confirming transactions before they settle through the exchange of money or securities.

Reuters could not determine further details about the infractions, including the identity of the affiliate or the nature of the transactions.

Consequences for breaching Regulation W can vary depending on the frequency and severity of the offenses, said Julie Hill, dean of the University of Wyoming College of Law, speaking generally about Regulation W and not specifically about Citi.

Regulators can start by issuing minor warnings and private notices that escalate in their urgency and harshness. Major violations can result in fines or public punishments known as consent orders, she added.

"The idea behind all of the rules and restrictions is to make sure that profits from the bank aren't siphoned off" in a way that jeopardizes depositors or drains a government insurance fund, Hill said.

Reuters could not determine whether regulators were aware of Citi's Regulation W breaches or inaccuracies in liquidity reporting.

COMPLIANCE RISK

Earlier this month, the Fed and the OCC fined Citi for "insufficient progress" in fixing data management problems and implementing controls to manage ongoing risks.

The bank has intensified its focus and increased its investment on the compliance efforts over the last several months, CEO Jane Fraser said at the time.

The two regulators have had Citi on notice since October 2020, when they issued regulatory punishments called consent orders over its risk management practices.

Since then, Fraser has said it is her top priority to transform the bank and address regulators' orders. Investors have rewarded her efforts with a 28% jump in Citi's stock this year, outpacing some rivals.

(Reporting by Lananh Nguyen and Tatiana Bautzer in New York, additional reporting by Saeed Azhar, editing by Megan Davies, Paritosh Bansal and Anna Driver)