SUNNY SUN ROBERT LOR 2 INDUSTRY OVERVIEW INDUSTRY OVERVIEW Banks Operating in Canada Domestic Bank Foreign Bank Subsidiaries fullService Foreign Bank Lending Bank 3 4 Royal Bank of CanadaRBC ID: 1029913
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1. ROYAL BANK OF CANADACATHY MASUNNY SUNROBERT LOR
2. 2INDUSTRY OVERVIEW
3. INDUSTRY OVERVIEWBanks Operating in CanadaDomestic BankForeign BankSubsidiaries, full-Service Foreign BankLending Bank3
4. 4Royal Bank of Canada(RBC)-$142.86BToronto-Dominion Bank(TD Bank)-$123.38BBank of Nova Scotia(Scotiabank)-$95.19BBank of Montreal(BMO)-$64.83BCanadian Imperial Bank of Commerce(CIBC)-$46.18BINDUSTRY OVERVIEWTop Five Banks
5. 5REGULATIONS
6. REGULATIONSBank ActPurposeProtecting depositors fundsInsuring the maintenance of cash reservesPromoting the efficiency through competitionSchedule I - Banks are widely held and domestically ownedSchedule II - Banks are held and owned by their foreign parent companiesSchedule III - Foreign banks have been given permission to operate in Canada, not incorporated with Bank Act6
7. REGULATIONSBasel CommitteeEstablished in 1930 in Basel, SwitzerlandBasel is a committee of banking supervisory authorities that was established by the central bank in 1974The objective of Basel is to understand of key supervisory issues and improve the quality of banking supervision internationally7
8. REGULATIONSBasel I Founded in 1988Sets out the minimum capital requirement of financial institutions to minimize credit riskCapital adequacy risk categorizes the assets of financial institutions into five categories(0%, 10%, 20%, 50%, 100%)Banks operate internationally are required to have a risk weight of 8% or less8
9. REGULATIONSBasel II A Guideline to calculate minimum regulatory capital ratio and confirm the 8% minimum coefficient for regulatory capital over risk-weighted assetsDivided eligible regulatory capital into three tiersHigher the tier, the less subordinated securities allowed to includeEach tier set by certain minimum percentage of regulatory capital 9
10. REGULATIONSBasel III Tighter capital requirement compares to Basel I and Basel IIImprove the banking sector’s ability to deal with financial stress, improve risk management and strengthen the bank’s transparency Bank’s regulatory capital is divided into:Tier 1Tier 2Tier 310
11. REGULATIONSTier 1 Capitial The most perfect form of bank’s capitalA core measure of a bank’s financial strength from a regulator’s point of view.Included core capital, disclosed reserves and non-redeemable non-cumulative preferred stockBasel III was developed in order to respond to deficiencies in financial regulation11
12. REGULATIONSTier 2 CapitalTier 2 captial is the secondary component of bank capital and designated as supplementary capitalConsider less secure than Tier 1 capitalOverall bank capital requirement partially based on weighted risk of bank’s assets12
13. REGULATIONSTier 3 CapitalTertiary capital held by bank to meet the market risk, include greater variety of debt than Tier 1 and Tier 2 capitalsTier 3 capital include greater number of subordinated issues, undisclosed reserves and general loss reserves compared to Tier 2 capital13
14. 14BACKGROUND OF RBC
15. 1981Grew its international lending abilities by partnering and eventually buying out several European banks1864Founded in Halifax as the Merchants Bank of Canada, grew rapidly in the Maritime region 19011929Became the first Canadian bank to exceed $1 billion in assetsChanged name to Royal Bank of Canada, with 64 branches across Canada 1950sChanges to the Bank Act allowed RBC to issue mortgage loans for the first timeBACKGROUND15
16. 2015Acquired L.A.-based City National Bank, the “bank to the stars”, for $5 billion1988Bought 67% of Dominion Securities,to diversify its operations outside of banking and into wealth management19992006Entered the Chinese mutual fund market by forming a joint venture with Minsheng Bank, holding a 30% stakePlans to merge with Bank of Montreal were rejected by the Canadian government, to protect competition in the industry2011Due to integration issues, sold its U.S.-based retail banking division, which it had acquired in 2001BACKGROUND16
17. 17BACKGROUNDMarket SharesRBC earned the highest revenue in the industry
18. 18BACKGROUNDManagement TeamDavid I. McKayPresident & Chief Executive OfficerAppointed president on Feb. 16, 2014 and CEO on Aug. 1, 2014Responsible for banking business in Canada, the US and the CaribbeanMBA from the University of Waterloo and honorary Doctor of Laws degree from Ryerson UniversityRod BolgerChief Finance Officer Joint RBC in 2011Responsible for setting the overall strategic direction of RBCGraduate of Georgetown University in Washington D.C. and MBA from Columbia University
19. 19BACKGROUNDManagement TeamMark HughesCROJoint RBC in 1981 and appointed CRO in 2014Responsible for overseeing the strategic management of risk on an enterprise-wide basisMBA from Manchester Business Schooland LL.B from Leeds UniversityJennifer ToryChief Administrative OfficerProviding leadership and oversight of transformational initiatives and focus on how the enterprise works together to further RBC’s successICD.D designation at Rotman School of Management
20. 20BACKGROUNDCorporate Governance Structure
21. BACKGROUNDGoalsObjectivesIn Canada:To be the undisputed leader in financial servicesMaintain position as market leader and grow by targeting key client segmentsIn the U.S.:To be the preferred partner to corporate, institutional and high net worth clients and their businessesUse City National Bank (acquired 2015) as a platform for long-term growth and opportunity to build deeper client relationshipsIn select global financial centers:To be a leading financial services partnerFocus on key operational hubs in Asia, the U.K., Europe, and the CaribbeanTo be among the world’s most trusted and successful financial institutionsMissionMission, Goals & Objectives21
22. BACKGROUNDStrengthsWeaknessesOpportunitiesCan leverage strong brand and position as largest bank in Canada to appeal to newcomers Enhanced combined capabilities (City National Bank) increases potential for increased sales from cross-selling/referralsCurrent branch network could see less traffic if clients move all their banking to digital channelsThreatsConsumers trust RBC for its strong brand reputation and deep relationships, making them less likely to switch to online-only banksFinTech could eventually become sophisticated enough that many clients will no longer need to visit branches, making them even more costly to runSWOT Matrix22
23. 23BACKGROUNDMajor Products and Services 5 profit segment:Personal & Commercial Banking Wealth Management Insurance Investors and treasury services Capital markets
24. 24BACKGROUNDEarnings
25. 25BACKGROUNDStock Trend
26. 26FINANCIAL STATEMENT ANALYSIS
27. 27FINANCIAL ANALYSISBalance Sheet10.08% of total assets
28. 28FINANCIAL ANALYSISBalance Sheet Cont.10.51% of total liabilitiesMaintain the 94% of the total assets
29. 29Income StatementHedging purposeFINANCIAL ANALYSIS
30. 30Income Statement Cont.FINANCIAL ANALYSIS
31. 31Comprehensive IncomeFINANCIAL ANALYSIS
32. 32Cash FlowsFINANCIAL ANALYSIS
33. 33Cash Flows Cont.$2296 Net Cash FlowFINANCIAL ANALYSIS
34. 34FINANCIAL ANALYSISGrowth and Strength
35. 35RISK MANAGEMENT STRUCTURE
36. 36RISK MANAGEMENT STRUCTURE
37. 37RISK MANAGEMENT STRUCTURE
38. 38RISK MANAGEMENT STRUCTURERisk Governance
39. 39RISK MANAGEMENT STRUCTURERisk Governance – Board of DirectorsEstablishes tone Approves Risk AppetiteProvides Risk OversightConsists of 4 main Committees:RiskAuditGovernanceHuman Resources
40. 40RISK MANAGEMENT STRUCTURERisk Governance – Group Executive & Group Risk CommitteeProvides recommendations of enterprise risk appetitesEnsures that resources and expertise available are adequatePlays significant roles in aligning:Strategic PlanningFinancial Planning Capital Planning; and Risk Appetite
41. 41RISK MANAGEMENT STRUCTURERisk Governance – First Line of DefenceRisk OwnersConsists of the business and support functions that are essential for maintaining and facilitating daily business operations.Responsible for identifying, assessing, mitigating, monitoring and reporting risk
42. 42RISK MANAGEMENT STRUCTURERisk Governance – Second Line of DefenseRisk Oversight Provides risk guidance and oversees the performance of the First Line risk management practicesAnalyzes risk management practices to determine the level of risk
43. 43RISK MANAGEMENT STRUCTURERisk Governance – Third Line of DefenceIndependent AssurancePerform internal and external audit Assure the Board of Directors and all management levels of the effectiveness of the risk management strategies in helping to reach towards the targeted goals.
44. 44RISK MANAGEMENT STRUCTURERisk AppetiteThe amount and type of risk that is toleratedHelps to minimize undesirable outcomesEnsures that these 3 features are adequate and acceptable during times of stress:Earnings at riskCapital at riskLiquidity
45. 45RISK MANAGEMENT STRUCTURERisk Conduct and CultureEstablished core set of policies and values that must followed to control corporate risk and help achieve favourable results:Shared set of behavioural norms that sustains the core values and enables to proactively identify, understand and act upon the risks, thereby protecting the clients, safeguarding our shareholders’ value, and supporting the integrity, soundness and resilience of financial markets.
46. 46RISK MANAGEMENT STRUCTURESteps to Take to Support Desired Outcomes
47. 47RISK MANAGEMENT STRUCTURERisk MeasurementExpected LossAssesses Earnings at RiskRepresents the amount of losses that are expected to occur under normal circumstances over a specific time horizon by using statisticsUnexpected LossAssess Capital at RiskEstimates how much the actual earnings will differ from the expected earnings over a specific time horizon
48. 48RISK MANAGEMENT STRUCTURERisk MeasurementStress Testing (enterprise-wide, risk specific, ad hoc, reverse)Examines the impact that possible unfavourable events can causeResults are used for:Monitoring Risk ProfileIdentifying Key Risks and Setting LimitsImproving actions for mitigationDetermining whether Capital and Liquidity Levels are sufficient
49. 49RISK MANAGEMENT STRUCTURERisk MeasurementBack-testingPerformed every 3 monthsTests market and credit risk parameters such as the probability of: default, loss given default, and usage given defaultCompares realized values to paremeter estimatesValidation of Measurement ModelsEnsuring that risk management models are current and still effective in meeting the companies main objectives
50. 50RISK MANAGEMENT STRUCTURERisk Control: Optimize Risk and ReturnThe enterprise-wide risk management approach is supported by a comprehensive set of risk controls. The risk management frameworks and policies are organized into the following five levels:
51. 51RISK MANAGEMENT STRUCTURERisk Pyramid: Identifies and Catogorizes Risks
52. 52RISK MANAGEMENT STRUCTUREMain Risks of RBC Credit RisksMarket RisksLiquidity and Funding RisksInsurance RisksOperational Risks
53. 53RISK MANAGEMENT STRUCTURECredit Risks: Managed by 3 Lines of DefenceRisk of loss that is related to the probability that obligors would fail to meet their obligations in contractual agreements.Primary Obligors (Direct)IssuerDebtorCounterpartyBorrowerPolicyholderSecondary Obligors (Indirect)GuarantorReinsurer
54. 54Credit Risks MeasurementQuantifies obligors’ and portfolio’s credit risks to help control expected losses and minimize losses that are unexpected2 Principal ApproachesInternal Ratings Based Approach (IRB) – mostly usedStandardized Approach 3 Key Parameters Probability of default (PD) – Chances that an obligor of a specific rating would default over a specific time horizonExposure at default (EAD) – amount obligor is expected to owe at time of defaultLoss given default (LGD) – estimate of amount of EAD that is unrecoverableRISK MANAGEMENT STRUCTURE
55. 55RISK MANAGEMENT STRUCTURECredit Risks – Wholesale Risk
56. 56RISK MANAGEMENT STRUCTURECredit Risks – Counterparty Risk & Wrong-way RiskCounterparty RiskRisk that the bank undertakes because of the possibility that the “other” party who had agreed to a contract with the bank defaults on their contractual obligationsNormally occurs during the trading of financial (options, forwards, swaps, futures and non-financial (commodities) derivative securitiesWrong-way Risk“Risk that exposure to a counterparty or obligor is adversely correlated with the credit quality of that counterparty”2 TypesSpecific Wrong-way RiskGeneral Wrong-way Risk
57. 57RISK MANAGEMENT STRUCTURECredit Risks – Retail RiskCredit Scoring is the main risk rating system used when acquiring new clients and managing existing clients.Retail Exposure risk is quantified on a pooled basis using following criteria:Behavioural Score, Product Type (Mortgages, Credit Cards)Collateral Type (Liquid Assets And Real Estate), Utilization Rate, Loan-to-value, AndThe Delinquency Status of the Exposure.
58. 58RISK MANAGEMENT STRUCTUREPool Exposures are used to estimate Credit Risk Parameters such as Probability of Default (PD) and Exposure at default (EAD)Credit Risks – Retail Risk
59. 59RISK MANAGEMENT STRUCTUREFramework for Controlling Credit Risk
60. 60RISK MANAGEMENT STRUCTUREGross Credit Risk ExposureLending-related and otherLoans and acceptances outstandingUndrawn CommitmentsContingent Liabilities (letters of credit and guarantees)Available-for-sale debt securities and depositsTrading-related creditRepo-style transactions Repurchase and Reverse RepurchaseLending and BorrowingDerivative amount Replacement Cost and Add-on
61. 61RISK MANAGEMENT STRUCTURE
62. 62RISK MANAGEMENT STRUCTUREProvision for Recovery of Credit Loss (PCL)2015 vs 2016Total PCL increased by 41% ($449 mil)PCL in Personal & Commercial Banking increased $138 million or 14%PCL in Wealth Management increased $2 millionPCL in Capital Markets increased $256 millionPCL in Corporate Support and Other increased $52 million
63. 63Gross Impaired Loans (GIL)RISK MANAGEMENT STRUCTURE2015 vs 2016Total GIL increased by 71% ($1,618 million)GIL in Personal & Commercial Banking decreased $158 million or 9%GIL in Wealth Management increased $532 millionGIL in Capital Markets increased $1,228 million
64. 64Allowance for Credit Losses (ACL)RISK MANAGEMENT STRUCTURE2015 vs 2016Total ACL increased by 10 ($206million) Personal & Commercial Banking ACL decreased by $28 millionTotal Allowance for Impaired Loans increased by $155 million
65. 65Market Risk – What’s it?RISK MANAGEMENT STRUCTUREDefined as the degree that changes in market prices can affect potential gains or lossesThese changes in market price can be associated with changes inInterest RatesCredit SpreadsEquity PricesCommodity PricesForeign Exchange Rates Implied Volatilities
66. 66Market Risk – How to Measure?RISK MANAGEMENT STRUCTURE
67. 67Market Risk ControlsRISK MANAGEMENT STRUCTUREValue-at-Risk (VaR) for RBCStatistical measure that quantifies the financial risk of individual and portfolio investments over a period of one day Measured at 99% confidence levelUpdated DailyStressed Value-at-Risk (SVaR)Same as VaR, but it is measured over a fixed historical one year period
68. 68VaR and SVaRRISK MANAGEMENT STRUCTURE
69. 69Trading Revenue and VaR (CAD Millions)RISK MANAGEMENT STRUCTURE
70. 70Liquidity and Funding RiskRISK MANAGEMENT STRUCTUREDefinition:Risk of the inability to efficiently and cost-effectively generate cash and cash equivalents to meet financial commitments already plannedRisk ControlReview and update objectives, policies, and strategies regularlyEnsure that Liquidity Risk is within the limits of the risk appetite statementsStress TestingMeasured based on the following 3 categories:Structural Liquidity Risk (Long term)Tactical Liquidity Risk (Short term)Contingency Liquidity Risk
71. 71Liquidity Coverage Ratio (LCR)RISK MANAGEMENT STRUCTURE ”LCR is a Basel III metric that measures the sufficiency of High Quality Liquid Assets available to meet liquidity needs over a 30-day period”
72. 72Insurance RiskRISK MANAGEMENT STRUCTUREDefinition:“potential financial loss that may arise where the amount, timing and frequency of benefit payments under insurance and reinsurance contracts are different than expected”Insurance Risk Framework is used to identify, assess, manage and report on the various insurance risks that the organization faces
73. 73Operational RiskRISK MANAGEMENT STRUCTUREDefinition:“Risk of loss or harm resulting from people, inadequate or failed internal processes and systems or from external events”Operational Risk FrameworkInternal EventsExternal EventsBusiness Environment and Internal Control Factors (BEICF) Assessments Scenario analysis BEICF monitoring
74. 74Operational RiskRISK MANAGEMENT STRUCTUREFactors That Can Significantly Impact Results: Model Risk, Information Technology Risk, Information Management Risk, Third-party Risk, Social Media,Processing And Execution Risk, Fraud
75. 75Other RisksRISK MANAGEMENT STRUCTURERegulatory Compliance RiskStrategic RiskReputation riskLegal and regulatory environment riskCompetitive RiskSystemic Risk
76. 76RISK MANAGEMENT STRATEGIES
77. 77RISK MANAGEMENT STRATEGIESDerivatives InstrumentFinancial Derivatives: Financial contracts whose value is derived from an underlying interest rate, foreign exchange rate, credit risk, and equity.Non-financial Derivatives: Contracts whose value is derived from precious metal and commodity derivative contracts in both OTC and exchange markets.
78. 78RISK MANAGEMENT STRATEGIESDerivatives Issued for Trading PurposesSales Activities: include the structuring and marketing of derivative products to clients to enable them to transfer, modify or reduce current or expected risks. Trading ActivitiesMarket-making: quoting bid and offer prices to other market participants with the intention of generating revenue based on spread and volume Positioning: managing market risk positions with the expectation of profiting from favourable movements in prices, rates or indices Arbitrage activities: dentifying and profiting from price differentials between markets and products
79. 79RISK MANAGEMENT STRATEGIESDerivatives Issued for HedgingInterest rate swaps Cross currency swapsForeign exchange forward contractsCredit derivatives
80. 80RISK MANAGEMENT STRATEGIES
81. 81RISK MANAGEMENT STRATEGIESDerivatives – Related to Credit RiskGenerated by the potential for the counterparty to default on its contractual obligations when the transactions have a positive market value Represented by the positive fair value of the instrument Normally a small fraction of the contract’s notional amount
82. 82