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Citibank: The Impact of Discount Rate Essay

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Updated: Sep 18th, 2021

Discount rate of the Federal Reserve System of the United States is an interest rate that defines the value of direct lending charged to commercial banks by FRS of the U.S. Discount rate is the most powerful instrument and is used by FRS very rarely; in all FRS history from 1934 it was used 114 times. More flexible mechanism refers to Federal Funds Rate – interest rate on which commercial banks trade by short-term loans of federal funds (Thornton, 2000).

There is a definite correlation between short-term borrowing from Federal Reserve funds and the level of the discount rate. If discount rate is reduced as in the case of recent developments connected with mortgage crisis in August, than short-borrowings of bank are risen in order to maintain liquidity. FRS reduced discount state from 6,25% to 5,75. That is why it is reasonable to aspire the rise of short-borrowing from federal funds by Citibank, which is the main bank entity in the Citigroup. The correlation of short-term borrowing from FRS and the level of discount rate show that high and stable discount rate results in low level of short-borrowing.

For instance, in 2004 when FRS discount rate was slightly higher that 6.25% level (6.5%) the level of average year short-borrowings was 212.132 (mln.$). In 2005 after the slight reduction of discount rate by 0.25% the rate of short-term borrowings increased to 290,663. The next reduction of discount rate in 2006 resulted in rise to 245.595 (Citigroup, 2006). Thus it can be with great precision predicted that due to the mortgage crisis and the necessity of rising liquidity in the end of the year Citibank will meet with large rate of short-term borrowings fro FRS. The precise number is difficult to predict but given the durability of “bubble” crisis the amount of liabilities to FRS will be the highest for the period of last 15 years.

Income tax and Citibank annual income rate

Corporate tax means a tax that is levied under various jurisdictions on the profits of companies and associations. As a common principle, the tax rates may substantially vary depending on the jurisdictions. In particular various allowances for capital expenditures and the amounts of interest payment that can be levied from the gross profits while elaborating tax liability may differentiate significantly. As well, tax rate can vary depending on the fact whether profits were transferred to minor and major shareholders or not. The reinvested profits may not be the object of taxing either.

Income taxes of Citibank in 2004 show that the level of corporate tax was higher in 2004 than in 2005. If in 2004 Citibank paid 17,639 mln. $ for corporate taxes in 2005 this number changed to 15,864 mln.$. Net income of the company, thus shows a great correlation with such economic indicator as corporate tax. The gradual decline of the corporate tax from 35 to 30 in the Citibank’s taxable income category influenced the rise of net income – in 2004 it was 17,045, in 2005 – 24,589, in 2006 – 25, 538 (Citigroup, 2006). On the basis of this correlation we may predict that this year will be met with gross increase of net income for Citibank.

It must be taken into consideration, though, that there are some other components, which can influence this variable. In the case of liquidity loss due to credit crisis the effect of net income will be damaging. Thus, while evaluating the correlation of these components we rely on the general trends for the certain period of time.

References

  1. Colander, D. C and Landreth, H. (1999). History of Economic Thought. 5th edition. Harcourt Press.
  2. Thornton, D. L. (2000). Lifting the Veil of Secrecy from Monetary Policy: Evidence from the Fed’s Early Discount Rate Policy. Journal of Money, Credit & Banking, 32(2), 155.
  3. . 2006.
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