Royal Bank of Canada
BUS419 Advanced Derivatives Securities
Jingyi Li
Qianyu Li
Ophelia Qian
Agenda
• Industry Overview
• Regulations
• Overview of RBC
• Financial Statement Analysis
• Risk Management Structure
• Major risks of RBC
Industry Overview
Schedule
• Schedule I banks are allowed to accept
deposits that are not a subsidiary of a foreign
bank
• Schedule II banks are a subsidiary of a
foreign bank allowed to accept deposits in
Canada
• Schedule III banks are foreign banks which
can do banking business in Canada
Canadian Banking Industry
• 28 domestic banks
• 24 foreign bank subsidiaries
• 26 foreign bank branches
• 3 foreign bank lending branches
Products and Services Segmentation:
Major players
• Royal Bank of Canada(21.7%)
• Bank of Montreal(12.9%)
• Canadian Imperial Bank of Commerce(16.2%)
• Scotiabank(14%)
• Toronto-Dominion Bank(21.6%)
• Other(13.6%)
Regulations
Basel I
• Primarily Focused on credit risk
• International Banks are required to hold capital
equal to 8% of their Risk-Weighted Assets
(RWA)
5 Categories of Assets
• 0% (for example cash, bullion, home
• 20% (securitizations such as mortgage-backed securities
(MBS) with the highest AAA rating)
• 50% (municipal revenue bonds, residential
mortgages)country debt like Treasuries)
• 50% (municipal revenue bonds, residential mortgages)
• and some assets given No rating
Basel II
• Three Pillars:
– Minimum Capital Requirements
• (Credit, Operational, Market)
– Supervisory Review
• (Systemic, Pension, Concentration, Strategic,
Reputational, Liquidity, Legal)
– Market discipline
• (Disclosure requirement)
Basel III
• Rather than require reserves for the whole
bank, Basel III requires different levels of
reserves for different for of bank deposits
and other borrowings
• To be fully implemented by 2019
Three Pillars
Capital Requirement
Common Equity Capital Raito
• Measures a bank’s financial strength
• Core equity capital compared with total riskweighted assets
Capital Conservation Buffer
• Countercyclical Capital
• Cushion for period of financial distress
Common Equity Tier 1 (CET1)
• Common Shares issued by the bank that meet the criteria for
classification as common shares for regulatory purposes (or
the equivalent for non-joint stock companies)
• Stock surplus (share premium) resulting from the issue of
instruments including CET1
• Retained earnings
• Accumulated other comprehensive income and other
disclosed reserves
• Common shares issue by consolidated subsidiaries of the bank
and held by third parties (i.e., minority interest) that meet the
criteria for inclusion in CET1
• Regulatory adjustments applied in the calculation of CET1
Additional Tier 1 capital
• Instruments issued by the bank that meet the criteria for
inclusion in Additional Tier 1 capital (and are not
included in CET1)
• Stock surplus (share premium) resulting from the issue
of instruments included in Additonal Tier 1 capital
• Instruments issued by consolidated subsidiaries of the
bank and held by third parties that meet the criteria for
inclusion in Additional Tier 1 capital and are not
included in Common Equity Tier 1. See section 4 for the
relevant criteria
• Regulatory adjustments applied in the calculation of
Additional Tier 1 Capital
Tier 2 capital
• Instruments issued by the bank that meet the criteria for
inclusion in Tier 2 capital (and are not included in Tier 1
capital)
• Stock surplus (share premium) resulting from the issue
of instruments included in Tier 2 capital
• Instruments issued by consolidated subsidiaries of the
bank and held by third parties that meet the criteria for
inclusion in Tier 2 capital and are not included in Tier 1
capital
• Certain loan loss provisions such as general
provisions/general loan-loss reserve
• Regulatory adjustments applied in the calculation of Tier
2 Capital
Liquidity Coverage Ratios
• Liquid assets enough to cover 30 days cash
outflows
• Stable funding to cover 1 year of extend stress
RBC’s Basel Ratios
Overview of RBC
Introduction- RBC
• The largest bank in Canada
• Operation in Canada, US and 40 countries
• Serves its 16.0 million clients through a network
of 78,000 employees
Five Business Segments:
• Personal and commercial banking
• Wealth management
• Insurance
• Investor and treasury services
• Capital markets
Results by business segment
Total Revenue
Additional trading information
Non-interest expense
Income and other taxes
Common share and dividend
Stock Chart
Financial Statement Analysis
Consolidated Balance Sheets
Consolidated Balance Sheets (Con’t)
Consolidated Statement of Income
Consolidated Statement of Income
Statement of Comprehensive Income
Consolidated Statement of CF
Consolidated Statement of CF
Risk Management Structure
Enterprise Risk Management Framework
Risk Appetite
Risk Control
Risk
Measurement
Risk Conduct
Risk
Governance
Risk Appetite
o Risk Appetite is the amount and type of risk RBC is able to
accept in the pursuit of their business objectives.
● “Earnings at Risk”---- expected loss
● “Capital at Risk” ---- unexpected loss
● Adequate liquidity throughout times of stress
Risk Capacity
Drivers & Self-imposed constraints
Risk Limits & Tolerances
Risk Profile
Risk Governance
Three Lines of Defence Governance Model
Risk Measurement
•
Expected loss: represents losses that are statistically expected to occur in
the normal course of business in a given period of time. (Earnings at Risk)
•
Unexpected loss: is a statistical estimate of the amount by which actual
losses can exceed expected loss over a specified time horizon, measured at
a specified level of confidence. (Capital at Risk)
•
Stress testing: examines potential impacts arising from adverse events
• Ongoing enterprise-wide testing program
• Risk specific stress testing program
• Ad-hoc
• Reverse stress tests
Risk Measurement
• Back-testing: to ensure the credit risk parameters remain
appropriate for use in regulatory and economic capital calculations.
• Validation of measurement models evaluates:
• The applicability of the model’s logic, its assumptions and
theoretical underpinnings
• The appropriateness of input data sources
• The interpretation of the model results
• The strategic use of the model outputs
Risk Control
Risk management frameworks and policies are organized into the following five
levels:
Level 1: Enterprise Risk Management
Framework
Level 2: Risk-Specific Framework
Level 3: Enterprise Risk Policies
Level 4: “Multi-risk” Enterprise Risk
Policies
Level 5: Business Segments and
Corporate Support
Major Risks of RBC
Risk is defined as the potential for loss or an undesirable outcome with
respect to volatility of actual earnings in relation to expected
earnings, capital adequacy or liquidity. (RBC, 2014)
Risk Pyramid
Credit Risk
• Credit risk is the risk of loss associated with an obligor’s potential
inability to fulfill its contractual obligations.
• Credit risk may arise from the risk of default of
Primary
Obligors
Secondary
Obligors
•
•
•
•
•
Issuer
Debtor
Counterparty
Borrower
Policyholder
• Guarantor
• Reinsurer
Credit Risk- Measurement
Credit risk is quantified to manage expected credit losses and
minimize unexpected losses
• To measure credit risk and setting regulatory capital:
• Internal Rating Based Approach (IRB)
• Standardized Approach
• Key parameters of credit risk:
• Probability of default (PD):
• Exposure at default (EAD)
• Loss given default (LGD)
Credit Risk- Retail risk
• The retail portfolio is comprised of:
• Residential mortgages
• Personal loans
• Credit card loans
• Small business loans
Credit Risk- Retail risk
• Credit scoring
▫ Acquisition of new clients
▫ Management of existing clients
▫ Borrower characteristics are assessed based on PD & LGD
Credit Risk- Wholesale risk
• The wholesale portfolio comprises:
• businesses
• sovereigns
• public sector entities
• banks and other financial institutions
• certain individuals
• small businesses
Credit Risk- Wholesale risk
• The wholesale credit risk rating system
•
•
•
Assign a borrower risk rating (BRR)
Assign a PD to each BRR
Based primarily on internal default history
Credit Risk- Risk control
• Credit risk assessment
• Credit risk concentration
• credit concentration risk is arising from an overconcentration on single names, industry sectors, countries or
credit products within the portfolio.
• Credit risk mitigation
• Structuring of transactions
• Collateral
• Credit derivatives
Gross Credit Risk Exposure by Portfolio and Sector
Loans and Acceptances
Market Risk
• Market risk is arising from changes in market determined
variables such as interest rates, credit spreads, equity prices,
foreign exchange rates and implied volatilities.
• Risk control
• Value-at-Risk (VaR):
• measures potential loss for a financial portfolio at the 99th
percentile confidence level over one-day period
• Stressed VaR:
• is similar to VaR except that a fixed one-year period of
extreme volatility is used
• Stress Tests
Market Risk-Risk Control
o
VaR & SVaR
Market Risk-Risk Control
o
VaR
Market Risk-Risk Control
Liquidity & Funding Risk
• Liquidity and funding risk is the risk that unable to generate
or obtain sufficient cash to meet our commitments as they come
due.
• Liquidity Risk Mitigation:
• Appropriate balance between the exposure level and its
mitigation cost
• Broad funding access
• Comprehensive liquidity contingency plan
• Appropriate and transparent liquidity transfer pricing
and cost allocation
Risk Measurement
• Structural ( Long-term) liquidity risk
▫ Arising from mismatches in effective maturity between all assets and
liabilities.
▫ Cash capital and other structural metrics are used.
• Tactical (shorter-term) liquidity risk
▫ Apply net cash flow limits in Canadian dollar and foreign currencies.
▫ Assign a risk-adjusted limit to their aggregate pledging exposure and
individual limits.
• Contingency liquidity risk
▫ Arising from sudden stressful events.
▫ Liquidity contingency plan
▫ Stress tests: elements of scenario & sensitivity analyses
Risk Control
• Policies
• Approve policies that govern management, measurement
and reporting requirements for businesses and products.
• Authorities and limits
•
Limits for our structural liquidity risk positions are
approved at least annually and monitored regularly.
• Funding strategy
• Core funding, comprising capital, longer-term wholesale
liabilities and a diversified pool of personal and, to a
lesser extent, commercial and institutional deposits, is
the foundation of our structural liquidity position.
Regulatory Compliance Risk
• Regulatory compliance risk is arising from potential
non-conformance with laws, rules, regulations,
prescribed practices, contracts or ethical standards.
• Risk Management:
• Use regulatory compliance programs in business
activities and operations.
• Ensure regulatory compliance risks are identified and
assessed appropriately
• Design and implementation of specific controls.
• Monitoring and oversight of the effectiveness of the
controls
Insurance Risk
• Insurance risk refers to the potential financial loss
that may arise where the amount, timing and/or
frequency of benefit payments under insurance and
reinsurance contracts are different than expected
• Risk Management:
• Insurance Risk Framework
• Key processes and tools: Own Risk and Solvency
Assessment, etc.
• Insurance risk policies and procedures
Operational Risk
• Operational risk is the risk of loss from inadequate or
failed internal processes, people and systems or from
external events..
• Risk Management:
• Three lines of defence
• Operational Risk Framework
• Standardized Approach: operational risk capital
requirements and the allocation of capital
• Basel II Advanced Measurement Approach (AMA) as the
approved regulatory capital methodology.
Strategic risk
Risk that the enterprise or particular business areas will make
inappropriate strategic choices, or will be unable to successfully
implement selected strategies or related plans and decisions
Risk Management
● The heads of the business segments, the Enterprise Strategy Office,
Group Executive, and the Board of Directors will take responsibility
● Management of strategic risk is supported by the Enterprise
Strategy Group through the use of an enterprise strategy
framework that synthesizes business portfolio strategies with the
enterprise vision
Reputation Risk
Reputation risk is the risk that an activity undertaken by an organization
or its representatives will impair its image in the community or lower
public confidence in it, resulting in the loss of business, legal action or
increased regulatory oversight.
Risk Management
• Operate with integrity at all times in order to sustain a strong and
positive reputation.
• Protecting reputation is the responsibility of all our employees,
including senior management, and extends to all members of the
Board of Directors.
THANK YOU!
References
• RBC (2014). Annual Report. Retrieved from:
http://www.rbc.com/investorrelations/pdf/ar_2014_e.pdf
• http://en.wikipedia.org/wiki/List_of_banks_and_credit_uni
ons_in_Canada
• http://clients1.ibisworld.com.proxy.lib.sfu.ca/reports/ca/ind
ustry/majorcompanies.aspx?entid=1288
• http://www.centralbankbahamas.com/download/00100490
0.pdf