Canadian Chartered Banks – Example of RBC

Cora Wong

Boerge Hernes

Lutz Firnkorn

Thursday, 17 March 2005

Overview

• Structure of Industry

• Royal Bank of Canada

• Risk and Risk Management

• Use of Derivatives

• Stock Compensation Plans

• Capital Requirements

• Summary

Chartered Banks

• A type of financial institution

• Take deposits, issue personal and corporate loans, and invest in marketable securities

• Schedule I Banks

• Schedule II Banks

• Schedule III Banks

Chartered Banks (Cont.)

• Mature industry

• Consolidating but highly competitive

• Traditional division into 4 Pillars– Banks– Trust Companies– Insurance Companies– Investment Dealers

• Now own each other and cross-sell each others’ services

Chartered Banks (Cont.)

• 19 domestic banks, 29 foreign bank subsidiaries, 22 foreign branches

• Industry dominated by “Big 6”– Royal Bank of Canada– Bank of Montreal– Canada Imperial Bank of Commerce– National Bank of Canada– Scotia Bank– Toronto-Dominion Bank

Chartered Banks (Cont.)

• Big 6 hold over 92% of total assets in industry

• Canada’s Schedule I Banks=– Big 6 – Laurentian Bank of Canada– Canadian Western Bank– 11 other domestic banks

Regulatory Environment

• The Bank Act

• Central Bank– The Bank of Canada

• Office of the Superintendent of Financial Institutions (OSFI)

• Canada Deposit Insurance Corporation (CDIC)

Regulation in Global Context

• Bank for International Settlements (BIS)– Basel Committee on banking Supervision

• International group of banking supervisors

• Basel II – Revision of 1988 Basel Capital Accord (Basel I)

Royal Bank of Canada

• Schedule I Bank

• Canada’s largest bank as measured by assets and market capitalization

• 1300 domestic locations

• 40 offices in Caribbean

• Branches in more than 30 other countries around the world

Royal Bank of Canada

Net Income 2004 - Geographic Segment

Net Income 2004 - Business Segment

RBC- Products Offered

• Divided into 5 business segments– RBC Banking– RBC Investments– RBC Insurance– RBC Capital Markets– RBC Global Services

RBC- Banking

• Serves individuals, small and medium-sized business, and mid-market commercial clients

• Financial planning and advising on deposit accounts, investments, mutual funds, credit and debit cards, business and personal loans, residential and commercial mortgages

• RBC Royal Bank, RBC Centura, RBC Mortgage, RBC Builder Finance, RBC Royal Bank of Canada

RBC- Insurance

• Creditor, life, health, travel, home, auto and reinsurance products and services

• Offered through telephone, brokers, travel agents, the sales force and the internet

RBC- Investments

• Wealth management services

• Brokerage, financial planning, investment counseling, personal trust, private banking, investment management products and services

• RBC Investments, RBC Dain Rauscher, RBC Global Private Banking

RBC- Capital Markets

• Wholesale financial services to large corporations, government and institutions

RBC- Global Services

• Specialized transaction processing services to corporations and institutions

• Global custody, investment administration, correspondent banking, cash management, payments, trade finance

Royal Bank of Canada

Stock Price 2004-Today

35,00

45,00

55,00

65,00

75,00

85,00

95,00

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Royal Bank of Canada

Bank of Montreal

HSBC

Stock Price 2004-Today

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RBC

BOM

HSBC

Average Economic Capital by Risk Type [2004]

Economic Capital

The Risk Pyramid

Credit Risk

Definition: Risk of default on given loansCredit risk management:- Credit scoring models

- For consumer and small business credit- Applicant scoring model- Behavioral scoring model

- For commercial and corporate clients- Risk limits- Credit derivative contracts- Loan sales

Market Risk

Definition: Loss due to environmental changes

Types of market risk:• Equity risk• Foreign exchange rate and commodity

price risk• Interest rate risk• Debt specific risk• Credit spread riskMarket risk management:

– VaR– Sensitivity analyses– Stress tests

Liquidity Risk

Definition: Not to be able to meet financial commitments as they fall due

• Liquidity risk management– Structural liquidity risk management– Tactical liquidity management– Contingent liquidity risk management

• Funding strategy• Credit ratings

Insurance Risk

Definition: Risk associated with design and underwriting of insurance policies

• Sources of insurance risk1.Product design risk2.Product pricing risk3.Insurance underwriting risk

• Insurance risk management– Experience studies– Scenario testing– Diversification– Reinsurance

Operational Risk

Definition: Relates directly or indirectly to inadequate or failed processes, technology, and human performance or from external events

Operational risk management framework:• Risk and Control Self-Assessment (RCSA)• Loss Event Database (LED)• Key Risk Indicators (KRIs)

Off Balance Sheet Risk

Definition: Items that don't occur or not with the full amount on the balance sheet

• Derivatives• Special Purpose Entities

– Often not consolidated, they are also used as vehicles to take over risk

• Undertaken normally for Risk, Capital and/or funding management purposes

• Guarantees• Cause Market, Credit and Liquidity Risk

Exposure

The Risk Pyramid

• Interest Rate derivatives

• Foreign exchange Derivatives

• Credit Derivatives

• Equity Derivatives

• Other

Derivative types

• For sale and trading– Sales to clients, those can then hedge against risks– Trading involves market making, positioning and

arbitrage activities

• Also used for hedging– Fair Value Hedge– Cash Flow Hedge– Hedge of Net Investment in foreign operations – Economical Hedge

Derivative types (cont.)

Derivative types (cont.)

Limits for stock holdings

Remunerations

• Stock Options /SAR (Stock appreciation rights)– Executives– Employees

• Employee share ownership plan

• Deferred shares units DSUs

• Performance based deferred shares

Stock Option overview

Influence on EPS

• Share capital

• Economic capital : Target Equity Level for

Rating

• Regulatory capital

– Tier 1 4% / Tier 2 8%

– Basel II from 2007 on requires a more detailed

rating and risk access system

Equity & Regulatory Requirements

Regulatory Requirements-Risk Adjusted Assets

Regulatory Requirements-Equity

• Bank are risk takers

• Many sources of Risk

• Highly complex Risk Management

• Align risk appetite and corporate strategy

Summary

Thank you for your attention