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

risk-weighted 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 Conduct

Risk Governan

ce

Risk Measure

ment

Risk Control

Risk Appetiteo 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 GovernanceThree 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 ControlRisk 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

• Issuer• Debtor• Counterparty• Borrower• Policyholder

Secondary Obligors

• 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 over-

concentration 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 Controlo VaR & SVaR

Market Risk-Risk Controlo 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 RiskReputation 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_unions_in_Canada

• http://clients1.ibisworld.com.proxy.lib.sfu.ca/reports/ca/industry/majorcompanies.aspx?entid=1288

• http://www.centralbankbahamas.com/download/001004900.pdf