In an effort to diversify its revenue base, Citigroup Inc. ( C - Analyst Report ) is branching out into the identity proofing business, according to a Wall Street Journal report. The business is considered as fast-growing and Citi is the sole financial institution to have a clearance to vend identity cards.

Citi will commence issuing digital identity cards to the U.S. Department of Defense employees later this month. The company, however, sees a vast scope to build a new fee-based revenue source from this identity proofing business. With technological support, the identity cards may be used to get paychecks as well as make payments for business. This would enable Citi to generate fees from those transactions.

The deal could provide Citi an opportunity to seize considerable market share in a business which is projected to generate billions of dollars in annual sales. Currently, the prevailing rate for the nature of cards that Citi will issue is between $250 and $350 per piece. Moreover, considering the mix of several U.S. as well as foreign government agencies, the potential market is a huge one.

The Obstacles

However, there are several issues involved in this business, which are helping deter other big banks from entering this market. Notably, upfront costs of a significant amount are being incurred by Citi for opening offices, equipment purchases as well as costs for getting access to required data bases. There are also concerns about security difficulties and cyber attacks.

Past Foray

In fact, in the past, a conglomerate named IdenTrust was formed in 1998 by Citi, Wells Fargo & Co. ( WFC - Analyst Report ) , Bank of America Corp. ( BAC - Analyst Report ) and another 11 lenders. This business unit suffered problems related to increasing costs and incongruity with respect to technology.

As a result, the identity verification business has run into troubled waters. Moreover, there are liability concerns as well for cases of erroneous identity approvals.

However, according to the report, matching the identities on the government-issued papers is Citi’s responsibility. The company is liable for breaching any Defense Department rules.

Citi has two dozen contenders in the identity proofing business. These include Verizon Communications Inc. ( VZ - Analyst Report ) and Northrop Grumman Corp. ( NOC - Analyst Report ) .

Our Take

This move of Citi comes in the midst of tepid economic growth, stringent regulatory environment and increasing competition. Though upfront costs are involved, the revenue diversification that this business allows is encouraging. In fact, Citi is one of the top companies in the payments business.

Going forward, we believe that investments and efficiency savings would help in garnering solid market share. Improved credit trends are encouraging. Expense outlook is also impressive. In fact, one can consider a company like Citigroup as a value investment given its global footprint and attractive core business.

We also believe that the strategic business diversification measures will bear fruit in future for the company and its shareholders. Yet, a low interest environment along with a tough regulatory scenario raise our concern.

Citi shares currently retain the Zacks #3 Rank, which translates to a short-term Hold rating. Considering the fundamentals, we also maintain a long-term Neutral recommendation on the stock.